Changing Regulatory Environment

Assignment 1: Individual Research and Short Paper—Changing Regulatory Environment

A company’s operating strategy continues to change as the legal and political environment changes. When Argentina’s government assessed a local tax on consumer purchases using credit cards, American Express and other U.S. companies were already facing a highly inflationary market. To make up for lost revenues, American Express began to provide revolving credit products.

In this assignment, you will use the University online library resources and Internet resources to analyze the strategies companies use to deal with a change in regulations.

1. Select an MNC operating in the U.S. and discuss some of the implications of a changing regulatory environment, then address the following questions:

How do companies evaluate market conditions for potential regulatory changes? Can this type of change be anticipated? Why or why not? What resources do companies have when faced with these types of changes?Do you think companies should withdraw from the marketplace after new legal regulations are put in place? Explain.What are the considerations companies account for prior to making any decisions?

 

1. Select a U.S. company doing business in a foreign market, then address the following questions:

What legal market conditions did the U.S. Company face and how did it deal with them?Do you think that operating in foreign markets is similar to operating in domestic markets? Why or why not?How can companies compete and survive in a marketplace despite the threat of legal restrictions and taxation?

Write a 4-pages essay in Word format. Apply current APA standards for writing to your work. Use the following file naming convention: LastnameFirstInitial_M5_A1 .

By Wednesday, June 5, 2013

, submit your assignment to the
 M5: Assignment 1 Drop box
.

 

Assignment 2: Course Project Task 5—Risks of Unstable Economic Conditions (IKEA)

For this part of the project, you will examine the legal and economic implications of the strategies used by companies in unstable economic conditions.

Discuss how each of the following factors impacts your chosen MNC:

1. Issues operating locally

CustomersLegalEconomicCapital

2. Issues operating in multinational marketplaces

Governmental regulation from home countrySourcing productsImport export restrictionsCapital

 The risks the client company might anticipate when operating in a changing economic and regulatory environment. Analyze the MNC’s strategy in unstable economic conditions and post your comments to.

 

By Wednesday, June 5, 2013

Module 5 Readings

Early in the week, complete the following:

·

Read the overview for Module 5

· From the textbook, International business law and its environment, read the following chapters:

·

Regulating Import Competition and Unfair Trade

·

Imports, Customs and Tariff Law

·

The Regulation of Exports

· From the Argosy University online library resources, read:

· Global food regulatory issues impacting dairy foods. (2006). Dairy Foods, 107(10), 24. Retrieved from EBSCO database 

http://search.ebscohost.com/ login.aspx?direct=true&db=buh&AN=22840712&site=ehost-live

· Mustokoff, T., & Segal, T. P. (2008). Commentary: Advice for taxpayers with undeclared UBS Swiss bank accounts. Rhode Island Lawyers Weekly. Retrieved from EBSCO database 

http://search.ebscohost.com/ login.aspx?direct=true&db=bwh&AN=L54444801RILW &site=ehost-live

· Simon, E. Y. (2008). Limited-service brands build on global success. Hotel & Motel Management, 223(3), 36–38. Retrieved from EBSCO database 

http://search.ebscohost.com/ login.aspx?direct=true&db=buh&AN=30065201&site=ehost-live

· Trottman, M., Williamson, E., & Casey, N. (2008). Children’s product industry put in regulatory bind. Wall Street Journal – Eastern Edition, 251(142), A3. Retrieved from ProQuest database 

http://proquest.umi.com/ pqdweb?did=1496424611&sid=1&Fmt=2& clientId=11123&RQT=309&VName=PQD

· From the Internet, read:

· London, T., & Hart, S. (2004, August). Reinventing strategies for emerging markets: Beyond the transnational model. Journal of International Business Studies. Retrieved from 

http://e4sw.org/papers/JIBS

·

Module 5 Overview (1 of 2)

·

·

Can and should businesses use a successful strategy for growth across markets? Companies change their operating strategies as the legal and political environment changes. Today companies not only have to pace themselves to keep up with the changing environment, but they also need to “sprint” to stay ahead of the competition.

In 2007, Coca-Cola purchased Glaceau, the producer of Vitamin Water, for $4.1 billion. Coca-Cola purchased the company to boost its declining beverage sales in the U.S. and North American markets. After its rival PepsiCo purchased the Gatorade lineup of Quaker Oats, Coca-Cola was faced with trying to slow the drop-off in its sales. With the acquisition of Glaceau, Coca-Cola expected to increase its share in the noncarbonated drinks market, a market that currently commands double-digit growth. With its foray into the water and energy drink market, Coca-Cola had to ensure compliance with the regulatory requirements governing food and health in international markets. However, the company was already familiar with these regulations because of its other product lines such as Minute Maid Heart Wise. The other issues the company addressed were concerns about the disposable plastic bottles and import and franchise laws.

Module 5 Overview (2 of 2)

Reinventing Business: Changing Regulatory Environment Organizations at times find it necessary to reestablish their business in existing markets because some markets may no longer be viable because of changes in existing laws and regulations. In this module, we will assess the impact of a changing regulatory environment on organizations. For your assignment, you will compare the impact of legal and governmental regulations on an MNC operating in the U.S. and a U.S. company operating in a foreign market. You will also analyze the strategies companies use to deal with a change in regulations. For your course project, you will investigate the strategies used by companies inunstable economic conditions. You will examine the legal and economic implications of these strategies. You will also investigate issues companies face when operating in multinational marketplaces.

CHAPTER 11: Regulating Import Competition and Unfair Trade

The last two chapters examined the basic principles of world trade law found in the General Agreement on Tariffs and Trade, and in the dispute resolution cases of the World Trade Organization (WTO). The key principles dealt with nondiscrimination, MFN trade, national treatment, and the elimination of quotas and non-tariff barriers. A knowledge of that material is essential here because those concepts will be carried throughout this chapter as well as the remainder of the book. Chapter Nine described the basic principles of the GATT agreements and how the WTO’s dispute settlement procedures work. Chapter Ten looked at specific WTO side agreements related to opening access to foreign markets. It also examined trade regulation in different sectors, such as agriculture, services, and textiles.

This chapter covers two main areas: The first is the regulation of import competition through laws that safeguard domestic industries. These laws protect industries that say, “We’re doing the best we can to compete, but foreign competitors have lower wage rates, lower employee benefit costs, and fewer government rules, and they are becoming more efficient and more productive. They are shipping ever-greater quantities of products here, and we need time to adjust—to retool our plants and retrain our workers to become more competitive again. Just give us some time!”

The second area covers the regulation of unfair trade, and the two most common unfair trade practices in international business: dumping and government subsidies. You might hear a business manager say, “Foreign firms compete unfairly. They dump their goods in our market at ridiculously low prices. They absorb the losses until they drive us all out of business so they will have the whole U.S. market to themselves!” Or you might hear it said, “How can we expect to sell our products here at home when we cannot match the price of imports? We may be more efficient than our overseas competitors, but they are subsidized; they are paid by their own government, with their taxpayers’ money, to build products and ship them here. We have got to stop this!”

We will learn how import competition affects the private firm, and what remedies it might have against a barrage of competing imports or an unfair trade practice. We will learn what the firm can do at home by petitioning the appropriate government agencies for a legal remedy, and see what remedies its government can pursue through the World Trade Organization (WTO). Although we will focus on the United States, what you will study is not that different from what is done in Canada, the EU, or in many other countries. In part, this is due to the internationalization of trade law through the WTO agreements, which require that national laws meet basic guidelines.

Import regulation is a double-edged sword. Trade wars are often depicted in nationalistic terms as an us-against-them problem. Pictures of unemployed factory workers fill the television screens. Politicians call for greater protectionist measures. Of course, these familiar stories have two sides: U.S. autoworkers and manufacturers scream for the president to put high tariffs on imported cars and trucks. U.S. employees at foreign car dealerships shout that tariffs on cars and trucks will put them out of work. Yet the Japanese government claims that the Japanese manufacturers are only producing cars that Americans want. The few remaining U.S. manufacturers of display screens for portable computers call for protection against an onslaught of imports. Yet U.S. computer manufacturers who use the screens threaten to close shop in the United States and move overseas if more duties are placed on the imported screens. U.S. steelmakers want higher tariffs to protect them against imports of cheap imported steel, while U.S. manufacturers of large appliances that use that steel say they cannot pass the higher prices on to U.S. customers. U.S. manufacturers of high-tech products, who are dependent on export markets, fear that if the U.S. government imposes higher tariffs on imports, other countries will retaliate by doing the same to their products. Examples such as these come from every agricultural, industrial, and service sector of the world’s economy. Amid the clamor for protection against imports, calls for free trade come from the heads of those firms whose exports might suffer from foreign retaliation and from leaders of consumer groups concerned about the rising price of imported consumer products.

The discussion in this chapter attempts to break through this protectionism-versus-free-trade morass by focusing on how international rules serve as a check on these competing national political interests.

Even purely domestic firms that do not import or export must have an understanding of how governments regulate import competition. Virtually all domestic products compete with products made abroad, and U.S. managers require a knowledge of how U.S. trade policies and trade laws affect their firms’ competitive positions. Managers may need to determine whether legal action could forestall a flood of competing imports and on what grounds such a lawsuit could be based. Would an action for relief be brought in the courts or before an administrative agency? Do any government programs exist to provide benefits to workers whose jobs are lost due to import competition? In the United States, many industries have sought protection against foreign competition. Some notable examples include apparel, shoes, gloves, motorcycles, steel, chemicals, foodstuffs, microwave ovens, typewriters, minivans, glass, and automobiles.

SAFEGUARDS AGAINST INJURY

Economic and political realities often force nations to take temporary corrective action to protect a domestic industry from severe market disruptions and dislocations of the workforce resulting from increased imports. A country takes legal action to protect a domestic industry by granting import relief or adjusting imports, practices commonly known as safeguards against injury. Safeguards are emergency actions used to protect a domestic industry that produces a like or competing product from increasing volumes of imported goods (regardless of any wrongdoing or unfair trade practice by a foreign firm or foreign government). These safeguards include new tariffs, quotas, or other import restriction. The legal authority for a WTO member nation to safeguard its firms from injury comes from the “escape clause” in the General Agreement on Tariffs and Trade (1947) and from the WTO Agreement on Safeguards (1994).

The GATT Escape Clause

Nations enter into trade agreements and make tariff concessions in order to boost two-way trade. If one country agrees to a reduced duty on shoes in return for the other country granting a reduced duty on auto parts, one of them should be prepared to see an increase in imports of shoes and the other an increase in imports of auto parts. However, these increased imports can sometimes cause market disruption to competing domestic producers that is greater than had been anticipated. The original drafters of GATT in 1947 were aware of this and built in a mechanism, known as the GATT Escape Clause (Article XIX), that permits a country to temporarily “escape” from its tariff concessions or from other obligations under a trade agreement under certain conditions. Article XIX permits a country to take temporary corrective action to safeguard its domestic industry where (1) as a result of “unforeseen developments”; (2) and due to the effect of a tariff concession or obligation under a trade agreement; (3) “increased quantities” of an imported product; (4) are causing or threaten to cause “serious injury to domestic producers of like or directly competitive products.” Notice that the escape clause is not intended to be used as an excuse for raising tariffs just because there are increased imports of foreign goods, but rather it should only be used when the increase is a result of “unexpected developments,” such as a surge of imports resulting from an unexpected economic event. The most famous example of an “unforeseen circumstance” occurred around 1950 when sales of women’s fur felt hats in the United States “dropped of the charts” due to an unexpected change in fashion (known as the GATT Hatters’ Fur case). The change was completely unexpected; a few years earlier, the United States had granted a tariff concession when fur hats were at the peak of fashion. The following report of the WTO Appellate Body, Argentina—Safeguard Measures on Imports of Footwear, relied on the Hatters’ Fur case. The report discusses this and other safeguards issues.

Argentina—Safeguard Measures on Imports of Footwear

WT/DS121/AB/R (14 December 1999)

World Trade Organization Report of the Appellate Body

BACKGROUND AND FACTS

In 1997, Argentina initiated a safeguard investigation and determined that increased imports were the cause of serious injury to Argentine producers. Increased import duties were placed on imports of foreign-made footwear greater than those previously bound in Argentine tariff concessions. In effect, the import duty went from the bound rate of 35 percent to 200 percent. The increased duties were imposed on imports of footwear from all countries except those South American countries that were members of the regional MERCOSUR common market. After consultations failed, the European Communities (EC) requested a WTO panel to decide if Argentina had complied with the GATT agreements. The United States joined as a third party. The EC made several arguments: (1) Argentina’s administrative safeguard proceedings had failed to show that the surge in imports was the cause of injury to domestic producers and had failed to consider whether the injury to the domestic footwear industry was actually caused by other economic factors; (2) Argentina must impose safeguards without regard to the country of origin, and not solely on non-MERCOSUR countries; and (3) GATT Article XIX required that safeguard measures be imposed only if the increase in imports results from “unforeseen developments.”

The EC maintained that because the increases in imports resulted from lowered rates of duty that were freely negotiated between countries as a part of their tariff concessions, the increases could not be “unforeseen.” Argentina argued that the 1994 GATT Agreement on Safeguards abandoned this requirement. The panel held that the Argentine safeguards had violated the GATT agreements, but expressed its view that there was no requirement that the increases in imports be unforeseeable. Argentina appealed to the WTO Appellate Body.

REPORT OF THE APPELLATE BODY

Article XIX of the GATT and “Unforeseen Developments”

The provisions of Article XIX: 1(a) of the GATT 1994 [refers to the original GATT agreement of 1947] and Article 2.1 of the Agreement on Safeguards, which together set out the conditions for applying a safeguard measure under the WTO Agreement, read as follows:

GATT 1994 Article XIX Emergency Action on Imports of Particular Products

1. (a) If, as a result of unforeseen developments and of the effect of the obligations incurred by a Member under this Agreement, including tariff concessions, [emphasis added] any product is being imported into the territory of that Member in such increased quantities and under such conditions as to cause or threaten serious injury to domestic producers in that territory of like or directly competitive products, the Member shall be free, in respect of such product, and to the extent and for such time as may be necessary to prevent or remedy such injury, to suspend the obligation in whole or in part or to withdraw or modify the concession.

Agreement on Safeguards Article 2 Conditions

1. A Member may apply a safeguard measure to a product only if that Member has determined, pursuant to the provisions set out below, that such product is being imported into its territory in such increased quantities, absolute or relative to domestic production, and under such conditions as to cause or threaten to cause serious injury to the domestic industry that produces like or directly competitive products.

* * *

As to the meaning of “unforeseen developments,” we note that the dictionary definition of “unforeseen,” particularly as it relates to the word “developments,” is synonymous with “unexpected.” “Unforeseeable,” on the other hand, is defined in the dictionaries as meaning “unpredictable” or “incapable of being foreseen, foretold or anticipated.” Thus, it seems to us that the ordinary meaning of the phrase “as a result of unforeseen developments” requires that the developments which led to a product being imported in such increased quantities and under such conditions as to cause or threaten to cause serious injury to domestic producers must have been “unexpected.” With respect to the phrase “of the effect of the obligations incurred by a Member under this Agreement, including tariff concessions…,” we believe that this phrase simply means that it must be demonstrated, as a matter of fact, that the importing Member has incurred obligations under the GATT 1994, including tariff concessions.* * *

In our view, the text of Article XIX:I(a) of the GATT 1994, read in its ordinary meaning and in its context, demonstrates that safeguard measures were intended by the drafters of the GATT to be matters out of the ordinary, to be matters of urgency, to be, in short, “emergency actions.” And, such “emergency actions” are to be invoked only in situations when, as a result of obligations incurred under the GATT 1994, a Member finds itself confronted with developments it had not “foreseen” or “expected” when it incurred that obligation.* * *

In addition, we note that our reading of the clause—“as a result of unforeseen developments”…in Article XIX:1(a) is also consistent with the one GATT 1947 case that involved Article XIX, the so-called “Hatters’ Fur” case [which stated],

… “unforeseen developments” should be interpreted to mean developments occurring after the negotiation of the relevant tariff concession which it would not be reasonable to expect that the negotiators of the country making the concession could and should have foreseen at the time when the concession was negotiated.

Imposition of Safeguard Measures by a Member of a Customs Union

Argentina claims on appeal that the Panel erred by “imposing an obligation” on a member of a customs union to apply any safeguard measure on other members of that customs union whenever imports from all sources are taken into account in a safeguards investigation. Article 2 of the Agreement on Safeguards provides that “Safeguard measures shall be applied to a product being imported irrespective of its source.” On the basis of this reasoning, and on the facts of this case, we find that Argentina’s investigation, which evaluated whether serious injury or the threat thereof was caused by imports from all sources, could only lead to the imposition of safeguard measures on imports from all sources. Therefore, we conclude that Argentina’s investigation, in this case, cannot serve as a basis for excluding imports from other MERCOSUR member States from the application of the safeguard measures.

Serious Injury

We agree with the Panel that Articles 2.1 and 4.2(a) of the Agreement on Safeguards require a demonstration not merely of any increase in imports, but, instead, of imports “in such increased quantities … and under such conditions as to cause or threaten to cause serious injury.”… And this language in both Article 2.1 of the Agreement on Safeguards and Article XIX: l(a) of the GATT 1994, we believe, requires that the increase in imports must have been recent enough, sudden enough, sharp enough, and significant enough, both quantitatively and qualitatively, to cause or threaten to cause “serious injury” [emphasis added]. With respect to the requirement relating to “serious injury,” Article 4.2(a) of the Agreement on Safeguards provides, in relevant part:

In the investigation to determine whether increased imports have caused or are threatening to cause serious injury to a domestic industry under the terms of this Agreement, the competent authorities shall evaluate all relevant factors of an objective and quantifiable nature having a bearing on the situation of that industry, in particular, … the share of the domestic market taken by increased imports, changes in the level of sales, production, productivity, capacity utilization, profits and losses, and employment.

As the Panel found that Argentina had not evaluated two of the listed factors, capacity utilization and productivity, the Panel concluded that Argentina’s investigation was not consistent with the requirements of Article 4.2(a).

We agree with the Panel’s interpretation that Article 4.2(a) of the Agreement on Safeguards requires a demonstration that the competent authorities evaluated, at a minimum, each of the factors listed in Article 4.2(a) as well as all other factors that are relevant to the situation of the industry concerned. Furthermore, we do not dispute the Panel’s finding that Argentina did not evaluate all of the listed factors, in particular, capacity utilization and productivity.

Decision. The Appellate Body upheld the panel’s conclusion that Argentina had not shown that the increased imports were the cause of serious harm to the domestic footwear industry. The Appellate Body also agreed with the EC that Argentina’s safeguards must be applied without discrimination and could not be applied only to non-MERCOSUR countries.

Comment. The Appellate Body never addressed the issue of whether the increased imports of footwear were caused by “unforeseen developments.” Nevertheless, in an often cited portion of its report, the Appellate Body offered its opinion that the Agreement on Safeguards must be read together with GATT Article XIX, which contains the “unforeseen developments” requirement.

Case Questions

1. Why did the Appellate Body uphold the panel’s finding that the increased imports were not the cause of serious harm to European industry?

2. Why could Argentina not apply the safeguards only to footwear from Europe?

3. What is meant by “unforeseen developments”? Is it not foreseeable that any tariff concession will cause an increase in imports? Explain.

4. What remedies are available to a country in a safeguards action? What is meant in Article XIX when it states, “The member shall be free…to suspend the obligation in whole or in part or to withdraw or modify the concession”?

The WTO Agreement on Safeguards

The WTO Agreement on Safeguards (1994) provides details lacking in the escape clause and sets out the procedural steps that countries have to follow to use it. In order to apply a safeguard, a country must first undertake an administrative investigation, which includes a public hearing at which importers, exporters, and other interested parties can present evidence and their views of whether the safeguard would be in the public interest. In the United States, investigations are conducted by the International Trade Commission, an independent agency of the federal government. The investigating body is required to evaluate all relevant economic factors bearing on the industry’s position, and it must find that the increased imports are the actual cause of the domestic industry’s decline. If other factors are shown to be causing injury simultaneously, then the increased imports are not considered to be the cause. Emergency action can be taken without the investigation if clear evidence justifies the safeguards, but any additional tariffs imposed must be lifted within 200 days.

Global Safeguards.

Safeguards applicable to WTO member countries are often called global safeguards. As the term indicates, the safeguards are imposed on imports of specific products regardless of the country of origin. For example, if increased imports of nonrubber footwear are causing serious injury to a domestic industry, the safeguards must be applied “globally” to all imports of non-rubber footwear, regardless of where they are produced. Most countries also have special safeguards applicable to imports from China.

Limits on the Use of Safeguards.

The safeguards agreement places limits on safeguards because they are a temporary remedy to be used only until the problem is resolved. They may not exceed four years (with an extension to eight years). The tariffs or restrictions on imports may not be greater than necessary to prevent injury, and must be gradually lifted when conditions warrant. WTO Appellate Body reports have ruled that a safeguard “may not be more restrictive than necessary to prevent or remedy a serious injury and to facilitate adjustment.” Tariffs are the preferred safeguard. A quota, if used, may not reduce the quantity of imports below the average level of imports of the prior three years. Quotas should be allocated among supplying nations based on their proportion of the total quantity of imports during the preceding years. Safeguards can only be applied to imports from developing countries if a particular developing country is supplying more than 3 percent of the total imports of that product.

Trade Compensation.

WTO rules from the 1994 GATT agreements encourage a country imposing a safeguard to compensate a supplying nation for the burden the safeguard measure has imposed on it. For instance, if the United States imposes safeguard tariffs on imported bicycles and Taiwan supplies large numbers of bicycles to the United States, then the United States should make trade compensation to Taiwan by reducing tariffs on other Taiwanese imports in an equivalent amount. The countries are expected to negotiate trade compensation; if they fail to reach agreement, then the supplying nation may “suspend … substantially equivalent concessions” or raise tariffs in retaliation.

The WTO Committee on Safeguards.

Countries must notify the WTO Committee on Safeguards when taking safeguard actions. The committee reports to the WTO Council for Trade in Goods. It monitors compliance with WTO safeguard provisions and assists countries in negotiating trade compensation.

Safeguards against Injury under U.S. Law

The U.S. safeguards law is found in Section 201 of the Trade Act of 1974 as amended by the Omnibus Trade and Competitiveness Act of 1988 and the Uruguay Round Agreements Act. U.S. law does not follow the guidelines of GATT Article XIX and the WTO Agreement on Safeguards completely, but is similar. U.S. law does not refer to the term safeguards, but rather to “positive adjustment to import competition” or “import relief.”

Standard for Import Relief.

Under U.S. law, import relief can be granted when “an article is being imported into the United States in such increased quantities as to be a substantial cause of serious injury or threat thereof to the domestic industry producing an article like or directly competitive with the imported article.” The president may make an adjustment to imports (e.g., impose tariffs or quotas) only after an investigation by the U.S. International Trade Commission (ITC) and only if, in the president’s discretion, it will “facilitate efforts by the domestic industry to make a positive adjustment to import competition and provide greater economic and social benefits than costs.” Because of this discretionary power, a president who adopts free trade or free-market concepts might be reluctant to apply a safeguard remedy at all. Although largely political in nature, a president’s decision is usually based on the national interest.

ITC Safeguard Investigations.

A petition for relief from imports may be filed with the ITC by any firm, trade association, union, or group of workers, or by Congress or the president, or it may be initiated by the commission itself. The ITC gives public notice in the Federal Register of its investigation and hearings. If it finds that the requirements of the law are met, it may advise the president as to what action to take. The commission conducts public hearings at which interested parties may present evidence and make suggestions as to the form of import relief. The ITC prepares a detailed economic analysis of the affected market and then makes its determination. The factors that the commission considers in determining whether increased imports are a substantial cause of serious injury include:

1. A significant idling of productive facilities in the industry.

2. The inability of firms to operate at a reasonable profit.

3. Unemployment or underemployment in the industry.

4. Growing inventories.

5. A decline in sales, market share, production, wages, or employment.

6. A firm’s inability to generate capital for plant and equipment modernization or for research and development.

7. An actual increase in imports or in market share held by imports.

8. Other factors that may account for the serious injury to the domestic industry (e.g., incompetent management or lack of technological innovation).

U.S. law defines substantial cause as “a cause which is important and not less than any other cause.” (Review the requirements for applying a safeguard measure as set out by the WTO Appellate Body in the Argentina Footwear case.) The ITC may not consider overall economic trends, such as the impact of a recession on the industry, but must look at the impact of the increased imports. In the ITC report on the U.S. motorcycle industry, Commissioner Eckes found that increased imports of heavyweight motorcycles threatened serious injury to the petitioner, Harley-Davidson, despite the severe impact of a long recession on total sales in the industry.

In the event that a foreign country requests a WTO panel to review a U.S. safeguard decision, the entire investigative process comes under scrutiny. If a WTO panel reviews the fact-finding decisions of the ITC or of an investigative agency in another country, what is the standard of review? Several Appellate Body decisions have addressed this (including the Argentina Footwear decision in this chapter) and concluded that Article 11 of the Dispute Settlement Understanding obligates a panel to make an “objective assessment” of the facts, not by trying to determine the facts of the case anew, but by looking to see whether domestic agencies have evaluated all relevant facts and have provided an adequate and reasonable explanation about how the facts supported their determinations. This is a practical realization that judges in Geneva cannot gather facts and information from industries and expert witnesses around the world.

Available Remedies under U.S. Law.

Any relief granted by the president must be temporary (limited to four years, with an extension to eight years if the firms in the industry are making needed changes) and designed to allow those firms sufficient time to regain their competitive position in the market. Relief should only provide time to retool, modernize, streamline, recapitalize, improve quality, or take other actions to better meet new competitive conditions in the market. The president’s options for adjusting imports include (1) tariff increases; (2) tariff-rate quotas, which allow a certain number of articles to be imported at one tariff rate, while all excess amounts enter at a higher rate; (3) absolute quotas; (4) quotas administered through the auctioning of import licenses; (5) negotiated agreements with foreign countries that limit their exports to the United States; or (6) trade adjustment assistance for the domestic industry. (Item (5) is not permitted under WTO rules and is no longer used.)

Heavyweight Motorcycles & Engines & Power-Train Subassemblies

Report to the President on Investigation No. TA-201–47

United States International Trade Commission 1983

BACKGROUND AND FACTS

In 1982, the ITC instituted an investigation to determine if motorcycles having engines with displacement more than 700 cubic centimeters were being imported into the United States in such increased quantities as to be a substantial cause of serious injury, or threat thereof, to domestic industry producing like or directly competitive articles. The investigation was in response to a petition for relief filed by Harley-Davidson Motor Co., a U.S. firm. The investigation showed that from 1977 to 1981, U.S. shipments of motorcycles grew by 17 percent, with domestic production capacity increasing by nearly 82 percent (largely as a result of American Honda’s increased production in the United States). During that same period, the number of U.S. jobs increased by 30 percent. In 1982, however, consumption fell, domestic shipments declined, and employment dropped. In the first nine months of 1982, domestic shipments fell by 13 percent and inventories rose, leaving large numbers of unsold motorcycles. Production during that period showed a decline of 36 percent, profits were down by 20 percent, and employment was down by 12 percent. Inventories of imported motorcycles doubled in that period, representing a tremendous threat to Harley-Davidson. The country as a whole was in the midst of a recession, and demand for heavyweight motorcycles was depressed.

VIEWS OF CHAIRMAN ALFRED ECKES

* * *

It is evident that inventories of imported motorcycles have increased significantly during the most recent period. These increases exceed growth in consumption and surpass historical shipment trends for importers. The mere presence of such a huge inventory has had and will continue to have a depressing effect on the domestic industry. Also, given the natural desire of consumers for current design and up-to-date performance capabilities, motorcycles cannot be withheld from the market indefinitely. They must be sold. And given the realities of the market place, there is a strong incentive to liquidate these inventories as quickly as possible. The impact of such a massive inventory build-up on the domestic industry is imminent, not remote and conjectural.

I have seen no persuasive evidence that would suggest imports of Japanese heavyweight motorcycles will decline in the near future. Instead, the Japanese motorcycle industry is export oriented … exporting in 1982 some 91 percent of the heavyweight motorcycles produced in Japan. Because motorcycles of more than 750cc, which include the merchandise under investigation here, cannot be sold in Japan under current law, Japanese producers cannot consider domestic sales as a replacement for exports. The other option, which they apparently pursued in 1982, is to push export sales in the face of declining demand in the U.S. market. This tactic helps to maintain output and employment in the producing country but it shifts some of the burden of adjustment to competitors in the importing country. Evidence that the Japanese producers will seek to maintain a high level of export sales to the U.S. is found in an estimate of the Japanese Automobile Manufacturer’s Association. This organization estimated that exports of 700cc or over motorcycles to the United States for 1982 and 1983 would average 450,000 units or less for both years combined. That figure results in import levels higher than recent levels.

Finally, imports of finished heavyweight motorcycles pose a “substantial cause” of threat of serious injury. Under section 201(b)(4), a “substantial cause” is a “cause which is important and not less than any other cause.” In my view, there is no cause more important than imports threatening injury to the domestic motorcycle industry.

In reaching this conclusion I have considered the significance of the present recession in my analysis. Without a doubt the unusual length and severity of the present recession has created unique problems for the domestic motorcycle industry. Without a doubt the rise in joblessness, particularly among blue-collar workers, who constitute the prime market for heavyweight motorcycles, has had a severe impact on the domestic industry. Nonetheless, if the Commission were to analyze the causation question in this way, it would be impossible in many cases for a cyclical industry experiencing serious injury to obtain relief under section 201 during a recession. In my opinion Congress could not have intended for the Commission to interpret the law this way.

There are other reasons for doubting the domestic recession is a substantial cause of injury or threat to the U.S. industry. During the current recession, imports from Japan have increased their market share from domestic producers, gaining nearly six percentage points. Imports have taken market share from the domestic facilities of Honda and Kawasaki as well as Harley-Davidson.

Moreover, while the current recession has undoubtedly depressed demand for heavyweight motorcycles, economic conditions are beginning to improve in this country …. As demand responds to this improvement, the domestic industry will be pre-empted from participating in any growth because of the presence of a one-year supply of motorcycles poised and ready to capture market share. Consequently, not the recession, but the inventory of motorcycles coupled with anticipated future imports constitute the greatest threat of injury in the months ahead.

Decision. The commission recommended that incremental duties be imposed for five years at the declining rates of 45, 35, 20, 15, and 10 percent, in addition to the existing rate of 4.4 percent ad valorem.

Comment. President Reagan followed the commission’s recommendations, but added tariff-rate quotas of 5,000 units in order to keep the U.S. market open to European firms that exported to the United States in smaller quantities. The remedy has been considered one of the most successful uses of safeguards. Under protection, Harley-Davidson recapitalized, introduced quality control processes and just-in-time inventory control, and regained its competitiveness. Just a decade later, Harley was one of the most demanded motorcycles in the world, including in Japan. In 2003, Harley exported over 50,000 units worldwide.

Case Questions

1. In the early 1960s, Honda entered the U.S. motorcycle market with the slogan, “You meet the nicest people on a Honda.” During the next two decades, the Japanese company not only made motorcycling acceptable and fun but it also introduced motorcycles known for quality, dependability, and easy starting. By 1982, Japanese motorcycles had reached their peak sales in the United States. In the meantime, Harley-Davidson was plagued with quality and image problems. Do you think this should have been considered in the ITC’s recommendations or considered by President Reagan?

2. Assume that a domestic firm is not competitive in price and quality with foreign firms, but that it is protected from competition by high tariffs. What are the effects of the protection on the firm in the short term? How might it affect the firm’s competitiveness in the long term?

3. President Reagan later rejected recommendations to place quotas on footwear because of estimates it would have cost American consumers $3 billion in increased tariffs, and because there was no indication it would have helped American manufacturers return to competitiveness. How important do you think cost is to a president’s decision?

4. Although the administrative process is handled through a bipartisan, independent commission (the ITC), why is the process still very political?

Market Disruption from Chinese Imports.

Increases in imports from China are subject to special rules not applicable to other WTO countries. As a part of China’s admission to the WTO, the United States and China agreed that special safeguards would apply to imports from China until 2013. The safeguards were added to U.S. law in the U.S.-China Relations Act of 2000 (an amendment to Section 421 of the Trade Act of 1974). The statute requires the president increase duties or impose other import restrictions (as the president considers necessary) where the ITC finds that increased imports of Chinese products are causing or threatening to cause market disruption to domestic producers of like or directly competitive products. Market disruption occurs whenever imports of an article that is directly competitive with an article made in the United States are increasing rapidly so as to be a significant cause of material injury, or a threat of material injury, to a domestic industry. [Notice that it is easier to prove a safeguards case against China (by showing that imports are a “significant cause of material injury”) than it is to prove a case for global safeguards under Section 201 (whose standard is a “substantial cause of serious injury”)]. The ITC conducts an investigation and issues its report and recommendation to the U.S. Trade Representative, who is required to try to reach an agreement with China. If no agreement is reached, the matter is forwarded to the president. The president must order import relief unless it would be contrary to the national economic interest (having “an adverse impact on the United States economy clearly greater than the benefits of such action”) or to national security.

The president’s authority to order or deny relief was tested in Motions Systems Corp. v. Bush, 437 F.3d 1356 (Fed. Cir. 2006). Motions Systems, a U.S. manufacturer of parts for motorized wheelchairs, initiated a safeguard action against competing products from China. Although the ITC found that market disruption had caused material injury and recommended to the president that quantitative restrictions be placed on imports over a three-year period, President Bush refused to do so. He believed that safeguards would not benefit U.S. manufacturers, but would only divert imports from China to manufacturers in other foreign countries, and would lead to increased consumer prices. The U.S. Court of Appeals ruled that Motions Systems had no right to judicial review, that the president had not exceeded his authority, and that he had broad discretion to determine that import relief is not in the national economic interest of the United States. Throughout his presidency, President Bush consistently denied relief to American firms, despite findings by the ITC that market disruption had occurred and despite recommendations that relief be granted. The position of President Obama has been different. He responded to a 2009 petition from a labor union representing workers at U.S. tire plants by accepting the findings of the ITC and imposing an additional tariff on imported Chinese passenger and light truck tires equal to 35 percent above the MFN rate, and then declining over three years. The ITC had recommended a larger increase of 55 percent.

Trade Adjustment Assistance

Workers who become unemployed as a result of increased imports of foreign goods may be entitled to federal trade adjustment assistance (TAA). The Trade Adjustment Assistance Program was created by the Trade Act of 1974 and is administered by the U.S. Department of Labor. Petitions for TAA may be filed with the U.S. Department of Labor by a group of three or more workers, by an employer, by a state workforce or jobs agency, or by a labor union representing affected workers. For workers to be eligible to apply for TAA, the Secretary of Labor must determine (1) that a significant number or group of workers in a firm have become, or are threatened to become, partially or totally separated from their employment; (2) that the firm’s sales or production have decreased absolutely; and (3) that increased imports of like or directly competitive products contributed importantly to the separation and to a decline in the firm’s sales or production. Once a group of workers is certified as eligible, the workers in that group apply individually for benefits with their local state job agency office. Assistance to workers, in the form of cash benefits, tax credits, or vouchers, is available to cover the expenses of job search, retraining and relocation, and health insurance coverage. Under certain conditions, and in lieu of other benefits, workers age 50 or older who find reemployment at a lower wage rate have the option to receive a wage subsidy (a portion of the difference between what they were earning and what they can earn now). The American Recovery and Reinvestment Act of 2009 (ARRA) expanded the program to include workers in service industries and public agencies, and to workers whose firms have transferred production to outside the United States. The industries with the largest concentration of certified workers during the last two decades were automotive equipment, textiles and apparel, furniture, leather and leather products, industrial machinery, and electrical and electronic equipment. In 2007, the Department of Labor certified nearly 1,500 petitions covering approximately 145,000 workers. With the onset of the recession in 2008 and the passage of the ARRA, those numbers increased dramatically. The ARRA, however, is scheduled to expire at the end of 2010. A special TAA program exists for farmers, and it is administered by the U.S. Department of Agriculture.

Trade Assistance to Firms.

Trade adjustment assistance is not just available for U.S. workers but also for U.S. companies. This program is administered by the U.S. Department of Commerce. It is intended to help U.S. companies become more competitive. Companies are eligible if increased imports contributed importantly to a decline in sales and to the unemployment of a significant number of its workers. Twelve assistance centers nationwide help certified companies develop business recovery plans over a two-year period. The plans include such things as improving production capabilities, marketing, computer systems and Website development, and standards certification. In order to receive financial assistance, the certified firm must contribute its own matching funds.

UNFAIR IMPORT LAWS: DUMPING AND ANTIDUMPING DUTIES

Dumping is the unfair trade practice of selling products in a foreign country for less than the price charged for the same or comparable goods in the producer’s home market. It is a form of price discrimination that causes injury to domestic producers through artificially low prices against which those producers cannot compete at a profitable level. The original GATT agreement has prohibited dumping since 1947, and it has been illegal in the United States since 1916.

Antidumping laws are national laws that define dumping and that set out the administrative procedures and remedies available in dumping cases. Antidumping laws are used more frequently than any other type of trade law in both the United States and Europe. Virtually all developed nations have statutes, patterned after the GATT agreement, that permit the importing country to impose antidumping duties on dumped products to offset the unfair low price and to prevent injury to a domestic producer. China enacted its antidumping law in 1997. In the EU, the antidumping laws are imposed only on trade between a member country and a nonmember country. Japan has similar laws, although they are not widely enforced. Developing countries, such as Mexico, Brazil, Argentina, India, and Korea, also have antidumping codes.

The Economics of Dumping

The theories that explain the economic motivation for dumping fill entire volumes and are certainly beyond the scope of this book. At first glance, one might wonder what is wrong with consumers in one country being able to buy the products of another nation cheaply. As long as the products remain available at a reasonable market price, nothing is wrong. But the lower prices charged in an importing country are often not related to superior efficiencies in production. Rather, dumping is often intended to drive competitors out of business so that the dumping firms will ultimately be free to raise their prices to monopoly levels.

Dumping has become a fairly persistent problem in international trade, often practiced by those firms wishing to sell their excess production capacity at bargain prices to cover fixed costs and to avoid cyclical worker layoffs. As long as dumped products are not sold in the producer’s own country, causing price suppression in its home market, then the producer has everything to gain and little to lose. Some economists point out that dumping is not always predatory, but may be related to market conditions. An exporting firm may not be able to command the same prices from foreign buyers as in its domestic market, where it has brand recognition and greater market power.

Critics of antidumping laws claim that they injure consumers by “fixing prices” at high levels. Once the prices rise for imported products, domestic manufacturers follow suit by raising their prices as well. Critics note that antidumping laws are designed to correct an unfair trade practice and not to protect domestic companies. They also maintain that antidumping laws do not require the United States to assess the impact of additional duties on the public interest (i.e., the cost to consumers) and do not provide an exception for goods that are in short supply in the United States.

The WTO Antidumping Agreement

The GATT provisions on dumping are found in GATT 1994 Article VI and in the 1994 WTO Antidumping Agreement. The 1994 agreement provides complex rules for determining when dumping has occurred and for resolving dumping disputes.

Every WTO member country is expected to see that its national antidumping laws comply with the WTO rules. These national laws are reported annually to the WTO in Geneva and are easily accessed by anyone interested in a foreign country’s dumping laws at the WTO Website. In the United States, the Uruguay Round Agreements Act amended U.S. antidumping laws to reflect the new GATT provisions, which are incorporated into U.S. tariff law generally in Title 19 of the United States Code. In this section, our discussions apply generally to both the WTO antidumping agreement and to U.S. antidumping laws. However, laws or procedures specific to the United States are noted as such.

The WTO agreement provides that dumping occurs when foreign goods are imported for sale at a price less than that charged for comparable goods in the exporting or producing country. Antidumping duties may be imposed only when the dumping threatens or causes “material injury” to a domestic industry producing “like products.” The agreement requires that an importing country resort to antidumping duties only after conducting a formal investigation to determine both the amount of the dumping and the extent of material injury.

In the United States, there are two federal agencies involved in the investigation. The United States International Trade Administration (ITA) of the U.S. Department of Commerce determines whether the merchandise has been sold in the United States at a price less than normal value, and the International Trade Commission (ITC) determines whether this has caused, or threatens to cause, a material injury to U.S. producers of like products. Petitions for an investigation may be filed by producers of “like” and competing domestic products, including manufacturers, sellers, or labor groups. By law, one of the requirements is that the petition must be supported by U.S. producers or workers who account for at least 25 percent of the total production of the domestic like products. The ITA can poll industry and labor to see if that support exists.

Most WTO member countries have a similar administrative process, patterned after the WTO requirements. For example, in Canada, unfair trade law investigations are handled by the Canada Border Services Agency and the Canadian International Trade Tribunal.

Calculating the Dumping Margin.

Antidumping laws are designed to prevent foreign manufacturers from injuring domestic industries by selling their products in the United States below the prices that they charge for the same products in their home markets. The U.S. statute provides that antidumping duties may be imposed on imported merchandise if that merchandise is sold or likely to be sold in the United States at less than its fair value. Contrary to popular belief, dumping does not require that the foreign products be sold for less than the cost to produce them, although a sale at below cost is certainly “less than its fair value.” In order to determine whether merchandise is sold at less than fair value, the ITA compares the normal value of the merchandise, which is the price at which it is first sold for consumption in the exporting or producing country, to the export price, meaning the price of the good when sold in or for export to the United States. If the export price is less than the normal value of the product in the home market, then the sale is below normal value, or in the language of the U.S. statute, at less than its fair value. The price differential is known as the dumping margin. WTO rules require that the dumping margin use price and value figures that will result in a “fair comparison.” When dumping causes or threatens material injury to domestic producers of like products, the importing nation may equalize the price differential by imposing an additional tariff, above the normal tariff charged for that product. These antidumping duties are assessed in an amount equal to the dumping margin and are calculated for each individual exporter. Thus, if a Korean company sells a widget in Korea at $100 and sells the same widget in the United States at $80, then the dumping margin is $20 and an antidumping duty of $20 can be imposed on the imported widget. If the dumping margin is less than 2 percent of the value of the products, the dumping is considered de minimis and no duties are imposed.

Calculating the Export Price.

The export price is the price (usually the ex factory price without shipping charges) at which a product is sold to an unaffiliated or unrelated buyer in the importing country. When a price charged for a product does not reflect an “arm’slength” (freely negotiated) transaction, a constructed export price must be used. A constructed export price is used when the exporter and importer are “affiliated,” or related companies, or when the product’s price is “hidden” in some other type of compensatory arrangement (such as barter). In these cases, the constructed export price is deemed to be the price at which the imported product is first resold in its original condition to an independent buyer. For this purpose, an “affiliated buyer” is a U.S. company or corporation in which the foreign seller owns a 5 percent equity ownership or more, or one over which the foreign seller is in a position to control, manage, or direct. This may also include companies where the seller has a degree of control as a result of having an exclusive supplier arrangement or where the same individuals sit on the boards of directors of both companies.

Calculating the Normal Value of Like Products in the Exporting or Producing Country.

Normal value is the price at which foreign like products are sold for consumption in the exporting or producing country in usual commercial quantities and the ordinary course of business, and at the same level of trade—in other words, comparing wholesale sale to wholesale sale, or retail to retail—as the dumped product. If insufficient quantities of like products are sold in the exporting country to permit a fair comparison, then normal value is calculated on the basis of sales to third countries, or on the basis of a constructed value. Constructed value is calculated on the basis of what it might actually cost to produce the product in the exporting country, plus an amount for selling, administrative, packaging, and other expenses, and a reasonable profit.

What Is a “Like Product”?

One common problem in comparing the price of the dumped product to “like products” sold for normal value in the exporting country is defining the term like product. First, many antidumping actions are taken against an entire category, kind, or classification of merchandise, not just on a single item or product. The ITA will have to determine which products to include in its price analysis and which to exclude. Also keep in mind that in many cases the products sold by a manufacturer or producer in one country are not like those sold in foreign countries. For example, the range of qualities, specifications, or dimensions may differ. The goods may be packaged differently or in different quantities and bulk packs. There are endless examples. Steel tubing sold in one country may be different from that sold in another. Building materials may differ according to local construction codes. Electrical standards can require that products be assembled differently or use varying component parts. Consumer preferences often dictate significant changes in products when they are sold for export. All of these factors make it very difficult to compare the export price with the normal value of a “like product” in the exporting country.

Generally speaking, the ITA will look at many factors, including whether the products are identical in physical characteristics, whether they are produced by the same or different firms, whether they are made of the same or similar component materials, whether they are of equal commercial value, and whether they are used for the same purpose. The following case, Pesquera Mares Australes Ltda. v. United States, illustrates a typical problem that might face the ITA in determining a “like product.” It is actually one of the more readable opinions in this area of the law. (Most cases deal with far more complex industrial product classifications than salmon.) As you read, consider how the agency made its decision and the deference given to that decision by the Court of Appeals for the Federal Circuit.

Pesquera Mares Australes Ltda. v. United States (Chilean Salmon)

266 F.3d 1372 (2001) United States Court of Appeals (Fed. Cir.)

BACKGROUND AND FACTS

Pesquera Mares Australes, a Chilean salmon exporter, was accused of dumping salmon in the U.S. market at less than fair value. An antidumping petition was filed in 1997 by the Coalition for Fair Atlantic Salmon Trade. The U.S. Department of Commerce (ITA) conducted an investigation to compare the price of the salmon sold in the United States with its “normal value” in the home market. Finding no sales of Mares Australes’ salmon in Chile during that time, ITA based normal value on the price of the salmon sold in Japan. However, while the salmon sold in the United States was of the “premium” grade, the salmon sold in Japan was of both “premium” and “super-premium” grades. ITA nevertheless found that the salmon sold in Japan and in the United States had “identical physical characteristics” and thus were “like products” as defined by the U.S. statute. ITA then included the price of the super-premium Japanese grade in its determination of normal value. This resulted in the ITA finding a larger dumping margin and imposing higher antidumping duties. The duties were affirmed by the Court of International Trade, and Mares Australes appealed to the Court of Appeals for the Federal Circuit.

DYK, CIRCUIT JUDGE

* * *

[T]he antidumping statute specifically defines “foreign like product,” as … merchandise which is identical in physical characteristics…. In this case ITA…sought to identify salmon sold by Mares Australes to Japan that was “identical in physical characteristics” to salmon exported by that company to the United States. It is ITA’s interpretation of the phrase “identical in physical characteristics” that is at issue.

* * *

Mares Australes argued that the super-premium salmon it sold to Japan could not be considered “identical in physical characteristics” to the premium grade salmon it sold to the United States. As evidence of this distinction, the company stressed … that certain physical defects (such as external lacerations to the salmon) were present in premium but not super-premium salmon; that super-premium salmon enjoyed a darker, redder color than premium salmon; and that its customers in Japan, recognizing these physical and color distinctions, paid higher prices for premium-grade salmon…. But ITA noted that “the record also contains evidence that the distinctions between the two grades were, in practice, nominal….”

As support for its conclusion that super-premium was not a commercially recognized separate grade, ITA also pointed to commercial practice in countries (other than Chile) exporting to Japan, whose salmon industries did “not recognize any grade higher than ‘superior.’” [In its final determination] ITA stated: “… The Norwegian, Scottish, Canadian, and U.S. salmon industries do not recognize any grade higher than “superior.” The “superior” grade is consistent with the premium grade and permits minor defects…. Nonetheless, all salmon in this range are graded equally, and are comparable products in the market place. [Notice of Final Determination of Sales at Less Than Fair Value: Fresh Atlantic Salmon From Chile, 63 Fed. Reg. 31411 (June 9, 1998)]. ITA thus determined that “salmon reported as super-premium are in fact of premium grade,” and accordingly compared the sales of both super-premium and premium salmon to Japan to corresponding sales of premium salmon only in the United States. The practical consequences of ITA’s decision to classify the two grades of salmon as “identical in physical characteristics” was to increase Mares Australes’ dumping margin from the de minimis level (1.21%) to a final dumping margin of 2.23%.

* * *

This case requires us to interpret the phrase “identical in physical characteristics” as that phrase appears in the definition of “foreign like product” [U.S. Code]. In order to ascertain the established meaning of a term such as the word “identical,” it is appropriate to consult dictionaries. There are a variety of dictionary definitions of “identical.” Some require exact identity. See, e.g., American Heritage Dictionary, 896 (3d ed. 1996) (defining “identical” as “being the same” and “exactly equal and alike”)…. Others allow “minor differences” so long as the items are “essentially the same.” See, e.g., The American Heritage Dictionary, 639 (2d ed. 1991)…. We find nothing in the statute to suggest that Congress intended to depart from the ordinary definition of the term “identical.” But that leaves the question of which of the two common usages was intended by Congress: exactly the same or the same with minor differences?

We conclude that Congress intended the latter usage…. As Coalition for Fair Atlantic Salmon Trade points out, Congress could hardly have intended to require ITA in each and every instance to compare all the physical characteristics of the goods. It might not be possible, for example, with certain types of merchandise to “account for every conceivable physical characteristic” of that merchandise.

Despite our conclusion that Congress intended to allow identical merchandise to have minor differences, the phrase “identical in physical characteristics” [as used in the U.S. statute] remains ambiguous, and, as we learn from Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 104 S.Ct. 2778 (1984), ITA has discretion to define the term.

ITA has concluded that merchandise should be considered to be identical despite the existence of minor differences in physical characteristics, if those minor differences are not commercially significant. We conclude that this standard adopted by ITA constitutes “a permissible construction of the statute.”…We conclude that this finding is supported by substantial evidence, and that it has been adequately explained.

* * *

Decision. The Chilean salmon exporter (Mares Australes) was found to have violated the antidumping laws of the United States by selling foreign salmon in the United States at less than fair value. The super-premium salmon sold by Mares Australes in Japan was similar enough to the premium grade sold in the United States to be considered a “foreign like product,” the price of which should be included in determining the normal value for purposes of calculating the dumping margin.

Case Questions

1. What is the purpose of comparing the price of salmon sold in the United States to that sold in Japan?

2. Why did Mares Australes not want the ITA to compare the price of salmon sold in the United States to the price of the “super-premium” salmon it sold in Japan?

3. Explain the problem confronting the ITA in determining “foreign like product.” How did the court define that term?

Adjustments to Normal Value and Export Price.

Calculating the dumping margin requires a fair comparison of the price of the dumped product in the export market with the price of a like product sold in the ordinary course of trade in the exporting or producing country (i.e., the normal value). A fair comparison often requires adjustments to either the export price or to normal value to compensate for differences in the sale—comparing “apples to apples.” For example, if the German manufacturer of ball bearings must pay a sales commission to sales representatives for ball bearings sold in Germany but does not pay commissions on sales to the United States, then the difference must be accounted for in the calculation. Adjustments can be made for differences in the terms and conditions of sale, for the cost of ocean containers and packaging, for freight and warehouse expenses, customs brokerage fees, insurance on the goods in transit, and other expenses. Adjustments should also be made for differences in taxes, advertising and sales commission expenses, quantity discounts, and other factors that might legitimately cause the export price to be lower than normal value. The rules for making adjustments in U.S. dumping cases are spelled out in federal law.

Market Viability and Constructed Value.

A price comparison between the export price in the foreign market and the normal value of the product in the exporting country only works if the exporting country’s market is sufficiently viable. Market viability exists if the exporting country’s home market has sufficient sales to warrant using it as a price comparison. If the exporting country has insufficient sales of a like product, then the normal value is difficult to determine. When aggregate sales volume in the exporting country (the “home market”) is less than 5 percent of the aggregate sales volume of the dumped product in the U.S. market, the dumping margin is calculated by comparing the dumped product to the price of a like product exported to a third country. If sales to a third country are also insufficient to determine normal value, then a constructed value is used instead. Constructed value is the price of the dumped product compared to the cost of producing the product in the exporting country plus a reasonable amount for administrative, selling, and other costs and for profits. The amount of profit to be added into constructed value is based on either (1) actual profits in the transaction, (2) average profits on sales of the same product made by other producers, or (3) profits made on different products sold by the same producer.

Sales Below Cost.

If substantial quantities of a product are sold in the exporting country (or in a third country if that is used for comparison purposes) at a price below per unit cost of production (including fixed and variable costs plus administrative and selling costs), the below-cost sales may be disregarded in determining a dumped product’s normal value. A product is sold in “substantial quantities” if, over the period of one year, 20 percent or more of the sales in question are below cost. Normal value is then calculated on the basis of the remaining above-cost sales.

The Level-of-Trade Problem.

A producing firm that sells to its local market at a different level in the chain of distribution than in foreign markets presents a common problem in the evaluation of dumping cases. For example, a higher normal value frequently occurs when the producer sells directly to retailers or to end users in the home country, whereas in the export market the producer may be selling to distributors or to wholesalers. The dumping margin would be attributed to the different costs of sale and different markups required. In a situation such as this, known as a level-of-trade problem, the ITA adjusts the price differential so that figures for normal value and export price are comparable.

The Material Injury Requirement

Antidumping duties are only applied where the International Trade Commission finds that an industry in the United States is materially injured, or threatened with material injury, by reason of dumped imports. Material injury is injury that is “not inconsequential, immaterial, or unimportant.” In determining material injury, the ITC must consider all relevant economic factors. Factors used to determine material injury include (1) the volume of the dumped imports (Have-dumped imports increased significantly?); (2) the effect of the imports on prices in the domestic market for like products (Have prices been undercut significantly? Have prices been depressed? Are domestic firms unable to raise prices to cover increased costs?); and (3) the impact on domestic industry, including data on sales, profits, market share, productivity, wages, unemployment, growing inventories, and other measures of economic health. A finding of material injury must be reviewed every five years if the antidumping order is still in effect at that time. The “material injury” standard under the antidumping law is less than the “serious injury” standard in safeguard actions (studied earlier). Later in the chapter, we will see that another U.S. unfair trade law (on countervailing duties) will also rely on this definition of material injury.

WTO Dispute Settlement in Dumping Cases

Prior to the WTO agreement in 1994, the original General Agreement on Tariffs and Trade (1947) had been criticized for its inability to control dumping or resolve dumping disputes. The 1994 agreement created the WTO Committee on Antidumping Practices, which is responsible for assisting countries in implementing the agreement.

Dumping disputes may be taken to the WTO Dispute Settlement Body for negotiation or resolution. (The procedures for WTO dispute settlement were discussed in Chapter Nine.) The parties to dispute settlement are the nations involved and not the sellers and buyers of the dumped products—although individual companies often have considerable influence in initiating dumping investigations.

The WTO panel may review a final antidumping order of an administrative agency in the importing country to determine if it is consistent with the WTO Antidumping Agreement. The panel can look to see if the agency misinterpreted the provisions of the agreement or whether it properly followed all administrative procedures in an “unbiased and objective” manner. If the panel finds that an antidumping order violates WTO rules, the panel can recommend measures to be taken against the importing country. However, the scope of review of an agency’s investigation and antidumping order is limited.

A dispute panel cannot reconsider issues of fact determined during a dumping investigation or overturn an interpretation of the agreement made by the investigating agency. Thus, in reviewing U.S. dumping cases, a panel must accept the facts as found by the ITA and ITC in their investigations and look only to see whether the agencies correctly applied WTO law. This standard of review is similar to the process found in the United States in which courts of law review decisions of administrative agencies.

Dumping and Non-Market Economy Countries in Transition

The United States has special rules for calculating the dumping margin of products imported from countries whose political and economic systems rely heavily on government central control, rather than on free-market forces. These non-market economy countries (NME) have political and economic systems that are still rooted in the socialist principles of a state-controlled economy. Although almost all are in some degree transitioning to a private free-market economy (with a couple of exceptions, of course), many still have extensive government control. They can allocate resources according to state planning and set the price of raw materials or energy within their country. They might be able to provide free or subsidized transportation, insurance, or other services to government-owned industries. Wage rates may be controlled. The governments can set quotas for production output or for export volume. Investment may be heavily regulated and may involve a mixture of government ownership and private interests. Importantly for this discussion is that NME governments can control consumer prices at home and export prices for foreign sale. For this reason, in antidumping actions it is difficult or impossible to compare the “normal value” of a product sold in the NME market to the export price of the same product in the United States. To correct this, the ITA determines a “surrogate” normal value. The surrogate normal value is the value of the factors of production, including materials, labor, energy, capital costs and depreciation, packaging, and other general expenses, in a market economy country that is at a level of economic development comparable to that of the NME country and that is a significant producer of comparable merchandise. Added to that is an estimated amount for profit. If information is inadequate or not provided, which may be the case if the government does not want it released, surrogate normal value is the price at which comparable merchandise produced in market-economy countries that are a level of economic development comparable to that of the NME is sold in the United States or other countries. The ITA then presumes that the normal value established by the NME method is applicable to all firms in that industry, unless in an antidumping duty action a firm can prove that it is a market-oriented exporter.

Market-Oriented Exporters

In countries with a history of socialist or communist control, the transition to a market economy does not occur overnight. Rather, it might take place in steps, with the government freeing certain market sectors to competition or by selling state-owned companies through privatization. So, even if the exporting country has an NME, the ITA may look to see if the particular firm producing the dumped products in that country is a market-oriented exporter. A market-oriented exporter is an exporting firm in an NME country that is not under government control and that does business on competitive terms. Generally, management negotiates export contracts and prices autonomously, and the government does not share in the profits of the firm. Some industries in an NME country can also be considered market-oriented industries. A market-oriented industry is one in which resources (materials, energy, etc.) and labor costs are procured at free-market prices, where there is little government involvement in controlling production and capacity decisions, where prices are set by markets, and where the producers are mostly privately owned. Very few industries in NME countries have ever been given market-oriented industry status in U.S. antidumping actions. By agreement, the United States will presume that China is an NME country until 2016, and Vietnam until 2018.

In the following case, Bulk Aspirin from the People’s Republic of China, a French-owned chemical giant with a plant in the United States petitioned the government for antidumping duties against its Chinese competitors. The case will give you a good feel for the administrative process and the combative nature of the proceedings. As you read the case, and especially the comment that follows, consider the ironies in the case, the impact of the antidumping laws on workers and consumers, and the place of dumping laws in the future of the global economy.

Bulk Aspirin from the People’s Republic of China

Notice of Preliminary Determination of Sales at Less Than Fair Value

65 Fed. Reg. 116 (2000)

International Trade Administration, U.S. Department of Commerce

BACKGROUND AND FACTS

Rhodia Pharma Solutions is one of the world’s leading manufacturers of specialty chemicals, including acetyl-salicylic acid (bulk aspirin). With corporate headquarters in France, it has about 25,000 employees in offices and manufacturing plants in the United States and throughout the world. In 1999, Rhodia filed a petition with the Department of Commerce (“ITA” herein) alleging that imports from the People’s Republic of China (PRC) were being dumped in the United States for less than fair value. Based on industry information, Rhodia believed that their customers were paying less than half of Rhodia’s price for the same product. No other firms joined the petition, and Rhodia is apparently the only producer of aspirin in the United States at the time of this action. Rhodia’s petition identified several potential Chinese exporters of bulk aspirin. Only two Chinese firms, Jilin and Shandong, responded to the petition. The ITA sent questionnaires to Jilin and Shandong and to the Chinese government, asking that it be forwarded to other Chinese producers. Jilin and Shandong responded with the price and market information requested by the ITA. No other Chinese firms responded. After an investigation, the agency issued this preliminary determination.

PRELIMINARY DETERMINATION

The ITA has treated the PRC as a nonmarket economy (“NME”) country in all past antidumping investigations. A designation as an NME remains in effect until it is revoked by the ITA.

Separate Rates: Both Jilin and Shandong have requested separate company-specific rates. These companies have stated that they are privately owned companies with no element of government ownership or control. To establish whether a firm is sufficiently independent from government control to be entitled to a separate rate, the ITA analyzes each exporting entity. Under the separate rates criteria, the ITA assigns separate rates in NME cases only if the respondents can demonstrate the absence of both de jure and de facto governmental control over export activities.

Absence of De Jure Control [“by law”]: The respondents have placed on the record a number of documents to demonstrate absence of de jure government control, including the Foreign Trade Law of the People’s Republic of China and the Company Law of the People’s Republic of China. The ITA has analyzed these laws in prior cases and found that they establish an absence of de jure control … over export pricing and marketing decisions of firms.

Absence of De Facto Control [“in fact or reality”]:…Shandong and Jilin have each asserted the following: (1) They establish their own export prices; (2) they negotiate contracts without guidance from any governmental entities or organizations; (3) they make their own personnel decisions; and (4) they retain the proceeds of their export sales and use profits according to their business needs without any restrictions. Additionally, these two respondents have stated that they do not coordinate or consult with other exporters regarding their pricing. This information supports a preliminary finding that there is no de facto governmental control of the export functions of these companies. Consequently, we preliminarily determine that both responding exporters have met the criteria for the application of separate rates.

Use of Facts Available: The PRC-Wide Rate: U.S. import statistics indicate that the total quantity of U.S. imports of aspirin from the PRC is greater than that reported by Jilin and Shandong…. Accordingly, we are applying a single antidumping deposit rate—the PRC-wide rate—to all exporters [other than Jilin and Shandong] based on our presumption that the export activities of the companies that failed to respond to the ITA’s questionnaire are controlled by the PRC government. The PRC-wide antidumping rate is based on adverse facts available. The exporters that decided not to respond in any form to the ITA’s questionnaire failed to act to the best of their ability in this investigation. Thus—we are assigning the highest margin in the petition, 144.02 percent, which is higher than any of the calculated margins.

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Normal Value [NV]: Surrogate Country: Section 773(c)(4) of the Act requires the ITA to value the NME producer’s factors of production, to the extent possible, in one or more market economy countries that: (1) Are at a level of economic development comparable to that of the NME, and (2) are significant producers of comparable merchandise. The ITA has determined that India, Pakistan, Sri Lanka, Egypt, Indonesia, and the Philippines are countries comparable to the PRC in terms of overall economic development. We have further determined that India is a significant producer of comparable merchandise. Accordingly, we have calculated NV using mainly Indian values, and in some cases U.S. export values, for the PRC producers’ factors of production.* * *

Factors of Production: [W]e calculated NV based on factors of production reported by the companies in the PRC which produced aspirin and sold aspirin to the United States. Our NV calculation included amounts for materials, labor, energy, overhead, SG&A, and profit. To calculate NV, the reported unit factor quantities were multiplied by publicly available Indian and U.S. export price values.

Decision. Based on the calculations of normal value, two producers, Jilin and Shandong, were able to show that their export pricing was not under government control and received separate antidumping duty rates based on their individual dumping margins (which ranged from 4 to 42 percent). Bulk aspirin imports from all other Chinese exporters received the PRC-wide rate of 144 percent.

Comment. The final determination of dumping was made in 2000, the same year that the U.S. International Trade Commission found injury to the U.S. producers. In 2001–2002, the Court of International Trade reversed parts of the ITA’s methodology of obtaining surrogate values for certain factors of production because it was not based on substantial evidence. The ITA then changed its methods of calculating overhead, labor, and other factors. For example, instead of using a higher weighted average overhead factor, the ITA used figures from the lowest-cost Indian producer. Subsequently, Jilin and Shandong’s antidumping duties were cut to zero. In 2003, a Rhodia representative stated in testimony before the U.S. House of Representatives that at first the new duties had helped it regain customers and become profitable again, but when ITA changed its methodology and the antidumping duties disappeared, so did its customers. Rhodia’s business in the United States had been devastated. And with that, Rhodia closed the last remaining aspirin plant in America and moved it to—you guessed it—China.

Case Questions

1. What are the special problems of determining the dumping margin of goods exported from an NME country to a market economy country?

2. Why were two Chinese companies, Jilin and Shandong, singled out for special antidumping rates? Were they under government control?

3. Why is the ITA using a surrogate country, India, to determine normal value?

UNFAIR IMPORT LAWS: SUBSIDIES AND COUNTERVAILING DUTIES

In the last section, we saw how antidumping laws protect domestic industries from the unfair pricing policies of foreign producers. Here we look not at the conduct of those foreign firms, but at that of foreign governments, which grant subsidies to domestic companies that give them an unfair price advantage in foreign markets. Government subsidies have long been a widespread and systemic problem. Most subsidies are broad government programs used for the greater good, to achieve a specific social or economic policy. They might be tax credits to encourage alternative energy technologies or conservation, grants to the defense industry to aid in the development of new technologies or weapons, or incentives to rebuild old factories. Some subsidies are used to protect critical domestic industries, such as steel, aircraft, or agriculture. For instance, a government that enacts a tax credit for homeowners who install insulation, or energy efficient windows, is subsidizing the purchase and installation of those products to achieve environmental and economic objectives, whether those objectives are conservation or just a boost for makers of insulation and windows. Subsidies are granted by all nations to virtually all segments of their economies, including manufacturing and agriculture (recall our discussion of agricultural subsidies in the last chapter). The EU, the United States, and Japan each spend tens of billions of dollars annually on agricultural subsidies alone, including direct payments to farmers.

Subsidies have long been recognized as damaging to the international economy. Subsidized industries are able to sell their products in foreign markets at prices lower than would otherwise be possible, which distorts trade patterns based on comparative advantage and gives an unfair competitive advantage to subsidized industries. Subsidies might also encourage firms to embark on commercial ventures that, once the subsidy ends, may prove unprofitable or commercially disastrous. A good example is the Concorde supersonic aircraft, which was able to fly from Europe to the United States in less than half the time of a regular jet. The aircraft’s development by a consortium of European companies was spurred not by demand, but by a host of EU subsidies. In commercial use, the plane turned out to be highly unprofitable. The last Concorde was taken out of service in 2003. Without the subsidy, the plane would likely have proved too costly to have merited production in the first place.

Government subsidies for a program as large and well known as the Concorde, of course, are a matter of public information. However most subsidies involve industries and products that are smaller, less known, and less glamorous. Just a quick glance at recent subsidy cases, shows products such as crepe paper, electric blankets, narrow woven ribbons, furniture, or endless varieties of food, chemicals, or steel products. The fact that a subsidy might exist on an imported product is usually discovered by a competing firm that is affected by the unreasonable or unexplainable low prices offered to customers by a foreign competitor. Not surprisingly, knowledge of pricing, as well as rumors about government aid programs that affect pricing, fly quickly through most industries. If a subsidy (or dumping, for that matter) is expected, it is usually the affected industry that brings this to the attention of the appropriate government agency in its country.

WTO Agreement on Subsidies and Countervailing Measures

Subsidies have been regulated by the GATT agreement since 1947. Today, subsidies are governed by the original 1947 GATT agreement, by the WTO Agreement on Subsidies and Countervailing Measures (1994, SCM Agreement), and by national laws and regulations. The SCM Agreement defines subsidies, clarifies those subsidies that are permissible and those that are not, and sets out the procedures for resolving subsidy disputes.

Definition of a Subsidy.

A subsidy is defined in the SCM Agreement as a financial contribution, including any form of income or price support, made by a government that confers a benefit on a specific domestic enterprise or industry. Examples of financial contributions include:

1. A direct transfer of money, grants, or making loans at less than prevailing commercial interest rates, or providing loan guarantees that allow the company to receive loans at rates more favorable than nonguaranteed commercial loan rate.

2. Not collecting revenue or taxes otherwise due or providing tax credits.

3. Providing investment capital in a private company if the investment decision is inconsistent with the usual practices of private investors.

4. Furnishing goods or services (including the supply of energy or natural resources) other than general infrastructure.

5. Purchasing goods from firms at a higher price than would be paid in the marketplace.

Two key concepts to remember are that there must be a financial contribution from government that confers a benefit. Many WTO panels have addressed the meaning of these terms. Generally, the financial contribution must be made by government on terms that are more favorable than would otherwise be available in the marketplace, and the benefit must make the recipient better off than it otherwise would have been.

WTO Rules Apply to “Specific Subsidies.”

The SCM Agreement only applies to subsidies considered to be “specific.” Nonspecific subsidies are not prohibited. A specific subsidy is one given to a select company or limited number of companies, to a select industry or group of industries, or to firms in a select geographical region of a country. A subsidy is usually specific unless eligibility is automatic upon the meeting of certain neutral, objective criteria. For instance, suppose that tax authorities allow all corporate taxpayers to deduct $50,000 of the cost of new machinery as an ordinary operating expense in the year of purchase instead of the $25,000 that had been allowed. Because the criteria for qualifying for the tax reduction is objective and neutral, made generally available to all taxpayers, and does not favor one company or one industry over another, it is not specific and does not fall under WTO rules. Of course, government programs that benefit industry are common. So, clearly, not all specific subsidies are impermissible. In order for a specific subsidy to violate WTO rules, it must either be a prohibited subsidy or an actionable subsidy.

Prohibited Subsidies

The SCM Agreement provides for two types of subsidies: prohibited subsidies, and actionable subsidies. Prohibited subsidies are subsidies that are impermissible per se and banned under all conditions. Their harmful effects are presumed; no proof is needed that they cause any adverse effects to a foreign country or foreign competitor because they so clearly distort international competition between firms. The two types of prohibited subsidies are export subsidies and import substitution subsidies. An export subsidy is a subsidy made available to domestic firms upon the export of their product or made contingent on export performance. Examples of export subsidies might include a grant or tax credit to cover the cost of transportation of goods from a manufacturing site to an ocean port for shipment to foreign customers, a tax credit for energy consumption for use in manufacturing goods for export, or the special tax treatment of income earned on export sales. Another prohibited export subsidy would be a loan from a government agency on terms not available from commercial banks, and which is either conditional on the export of goods to a foreign customer or repayable only out of the proceeds of a contract of sale with a foreign customer. All export subsidies are deemed to be specific, as discussed in the last section, because they target a specific group of recipients—exporters. An import substitution subsidy is a government subsidy whose payment is contingent on its recipient using or purchasing domestically made goods over imported goods.

U.S.-Brazil Dispute over Cotton Subsidies.

Both export subsidies and import substitution subsidies were at issue in a dispute over U.S. subsidies to the U.S. producers and exporters of upland cotton. The United States is the world’s second largest producer of cotton (after China) and the largest exporter (China is a net importer), with almost 60 percent of production exported. The United States spends billions of dollars on cash payments, loans, and guarantees to boost U.S. cotton exports, lower the price of U.S. cotton on world markets, and raise farmer income. U.S. cotton subsidies have been the subject of a long-running trade dispute. At issue was a U.S. program that provided loan (“export credit”) guarantees to private lenders that financed shipments of cotton to countries where credit and financing were not available. In another “special competitiveness program,” the United States actually paid American textile mills and exporters to purchase U.S. cotton instead of lower priced foreign cotton. Brazil (joined by the EU and fourteen other cotton exporting countries) requested dispute resolution at the WTO claiming that the U.S. programs constituted prohibited subsidies under the SCM Agreement. (Brazil also claimed violations of the WTO Agreement on Agriculture, discussed in the last chapter.) In WTO Report on the United States—Subsidies on Upland Cotton, WT/DS267/AB/R (2005) it was held that the export credit guarantees were a prohibited export subsidy, and that the payments to mills and exporters constituted a prohibited import substitution subsidy, both in violation of the SCM Agreement. Brazil was then authorized to take retaliatory measures. Brazil announced that it would impose a tariff of 100 percent on 102 American-made products valued at $830 million and impose restrictions on U.S. intellectual property entering Brazil. Negotiations in 2010, just days before Brazil’s tariffs were set to begin, temporarily ended the dispute much to the relief of U.S exporters. The payments to U.S. mills were ended, discussions were still ongoing about modifications to the loan guarantee program, and the United States agreed to pay Brazil $147 million per year until a permanent solution to the cotton subsidy problem could be reached.

Actionable Subsidies

Actionable subsidies, also known as adverse effects subsidies, are the second type of subsidy addressed in the SCM Agreement. These are subsidies that, while not automatically prohibited, may still be “actionable” under WTO rules because of their harmful effect. An actionable subsidy is one that causes one or more of the following: (1) material injury to the domestic producers of a like product in the complaining country; (2) undermining of the complaining country’s interest in a trade agreement; or (3) “serious prejudice” to the interests of the complaining country. Serious prejudice is deemed to exist if the subsidy exceeds 5 percent of a product’s value, if the subsidy covers a firm’s operating losses, or if the government forgives a debt owed to it. In addition, the subsidy must have caused at least one of the following adverse effects: (1) it “displaced or impeded” imports of a like product produced in the complaining country into the market of the subsidizing country or into a third country; (2) it caused significant price undercutting, price suppression, price depression or lost sales in the same market; or (3) in the case of a “primary product or commodity,” it caused the subsidizing country’s world market share to increase during the time the subsidies were made. A request for dispute settlement for actionable subsidies may be brought only by a complaining country whose industry has suffered material injury, or that has suffered serious prejudice, as defined above.

Upstream Subsidies.

An upstream subsidy is a subsidy bestowed on raw materials or component parts (“inputs”) that are used in an exported product. For instance, a subsidy on coal might also be considered a subsidy on steel made in furnaces that burn that coal. A subsidy on European wheat might be considered a subsidy on Italian pasta made from that wheat. Similarly, a subsidy on live swine might be considered an upstream subsidy of processed pork exports. Upstream subsidies are subject to countervailing duties if the input product is made available at a below-market price and has a significant effect on lowering the cost of manufacturing the final product.

WTO Subsidy Dispute Settlement.

Subsidy disputes can be resolved either nation to nation, through the dispute settlement procedures of the WTO, or, as we will see in the next section, through administrative remedies available to injured domestic industries in the country where the subsidized products were imported.

Dispute settlement procedures in subsidy cases are similar to those used generally at the WTO, as discussed in Chapter 9. WTO dispute settlement begins with the complaining country’s formal request for “consultations,” and if unresolved can proceed to an investigation by a panel, a possible appeal to the Appellate Body, and consideration of their recommendations by the Dispute Settlement Body (DSB). If a subsidy is found, the DSB must recommend that it be removed or it may authorize the complaining country to take countermeasures through tariff increases and other measures in an amount needed to offset the subsidy. A WTO arbitration panel determines the amount of the countermeasures.

Countervailing Duty Actions

The second method for dealing with a subsidy is through administrative proceedings in the country where the subsidized goods are imported. All trading nations have some administrative process for addressing subsidized imports. These are commonly called countervailing duty actions. A countervailing duty is a special tariff, levied in addition to the normal tariff, imposed on imports of subsidized goods for the purpose of offsetting the subsidy. The result is that the cost of imported goods is brought back to where it would have been had the goods not been subsidized. The use of a countervailing duty discourages subsidization, eliminates market distortions and the harmful effects of the subsidy, and protects domestic industry in the importing country from injury. A countervailing duty action may be brought at the same time as the WTO dispute settlement action. However, only one form of relief is available: either the countervailing duty or a countermeasure approved by the WTO. All countervailing duty laws must comply with the SCM Agreement.

Countervailing Duty Actions in the United States.

U.S. countervailing duty laws date as far back as the late 1800s. The laws changed little over the years until recent decades, when they were revised to comply with the requirements of the SCM Agreement. Countervailing duty actions are administrative, similar to that used in antidumping duty cases, described earlier. In the United States, an action is begun by the filing of a petition with both the International Trade Administration (ITA) of the Department of Commerce, and the International Trade Commission (ITC). The ITA may initiate an action on its own, but that does not occur frequently. If the ITA finds that a subsidy exists, and the ITC finds that it caused “material injury” to domestic producers, then a countervailing order may be awarded. (The standard for “material injury” is the same as for antidumping duty actions, described earlier.) It generally takes from twelve to eighteen months for an order to be issued.

Subsidies and State-Owned Enterprises

Prior to 2007, the countervailing duty law was not applied to imports from non-market economy countries. The Department of Commerce did not believe that was the intent of Congress, and it seemed impossible to determine a level of subsidy in a government-controlled, centrally planned economy. By 2007, China’s economy had undergone many structural changes. In that year, the policy was reversed, and the ITA applied the countervailing duty law to a case involving imports of Chinese coated paper, used in quality, full-color publications. The change was due to the growing U.S. trade imbalance with China, the increasing foreign ownership of Chinese firms (including by Americans), the loosening of state control over many industries and firms, and demands from members of Congress to stop Chinese subsidies.

Exports from Newly Privatized Enterprises.

What happens when a state-owned enterprise transitions into private ownership? Do the subsidies once provided when the enterprise was government owned continue to benefit the now privately owned firm? Understand that state-owned enterprises exist not just in non-market economies or socialist countries but also in many countries that we think of as being “free market” or “capitalist.” These include Western nations like the UK, Sweden, and France, as well as developing countries such as Mexico, Chile, and Brazil. For example, government ownership of communications or energy industries is not unusual.

Since the late 1980s, there has been a worldwide trend away from government ownership of industry and toward private investment. This is known as privatization. The term privatization refers to the process by which a government sells or transfers government-owned industries or other assets to the private sector.

The next case, United States—Countervailing Measures Concerning Certain Products from the European Communities (European Steel), sees the largest European steel mills go from their days of near-financial collapse in the late 1960s, through a government bail-out and takeover of ownership, to a subsequent return to private hands decades later. The United States believed that the financial contributions made to the firms while they were government owned were benefits that passed through to the newly privatized companies. This, in turn, continued to permit low-cost steel exports to the United States. The issue ultimately reached the WTO Appellate Body in Geneva.

United States—Countervailing Measures Concerning Certain Products from the European Communities (“European Steel”)

WT/DS212/AB/R (9 December 2002)

World Trade Organization Report of the Appellate Body
BACKGROUND AND FACTS

During the 1960s and 1970s, the European steel industry was near financial collapse. With the support of labor groups, the largest firms were kept alive with government money, low-interest loans, and equity investments from European governments. Many mills became government owned. In the early 1980s, the equivalent of tens of billions of dollars of public money was used to keep the mills running. The money financed operations, revitalized equipment, lowered the firms’ debt, trained steelworkers, and permitted the export of low-priced steel. The United States responded with a host of trade remedies, including countervailing duties. When the political climate changed in Europe, governments decided to sell off their interests to private investors in free-market stock sales. Since 1988, many large steel mills have been privatized, including British Steel (today Corus), Germany’s Saar-stahl, France’s Usinor, and others. The new privately owned companies continued to sell steel in America.

The U.S. Department of Commerce (“ITA” herein) imposed countervailing duties on European steel imports despite the fact that the European mills had been privatized. It believed that the benefits endowed by the subsidies while the companies were government owned continued to “pass through” to the same steel companies (arguing that the companies were still the “same legal person”) even after the change in ownership. After all, it was assumed, the new shareholders received the modern equipment, trained workers, and other assets paid for by the government. The European Communities maintained that the privatizations took place at arm’s length and for fair market value, that the government no longer had any ownership interest or control, and thus that public monies were no longer subsidizing steel production. The EC argued that the U.S. “same person” rule violates the WTO Agreement on Subsidies and Countervailing Measures [SCM Agreement]. Consultations between the governments failed, and in 2001, the EC requested that the WTO Dispute Settlement Body convene a dispute panel. After the decision of the panel, the United States appealed to the Appellate Body.

REPORT OF THE APPELLATE BODY
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[W]e find that the Panel erred in concluding that “[p] rivatizations at arm’s length and for fair market value must lead to the conclusion that the privatized producer paid for what he got and thus did not get any benefit or advantage from the prior financial contribution bestowed upon the state-owned producer.” (emphasis added) Privatization at arm’s length and for fair market value may result in extinguishing the benefit. Indeed, we find that there is a rebuttable presumption that a benefit ceases to exist after such a privatization. Nevertheless, it does not necessarily do so. There is no inflexible rule requiring that investigating authorities, in future cases, automatically determine that a “benefit” derived from pre-privatization financial contributions expires following privatization at arm’s length and for fair market value. It depends on the facts of each case.* * *

With all this in mind, we now turn to the administrative practice of the ITA that is the source and subject of this dispute…. Generally, the ITA applies the “same person” method to countervailing duty determinations following a change in ownership.

* * *

The Panel stated, and the United States agreed before the Panel and on appeal, that the “same person” method requires the ITA to “consider that the benefit attributed to the state-owned producer can be automatically attributed to the privatized producer without any examination of the condition of the transaction” when the agency determines the post-privatization entity is not a new legal person. It is only if the ITA finds that a new legal person has been created that the agency will make a determination of whether a benefit exists, and, in such cases, the inquiry will be limited to the subject of whether a new subsidy has been provided to the new owners.

Thus, under the “same person” method, when the ITA determines that no new legal person is created as a result of privatization, the ITA will conclude from this determination, without any further analysis, and irrespective of the price paid by the new owners for the newly-privatized enterprise, that the newly-privatized enterprise continues to receive the benefit of a previous financial contribution. This approach is contrary to the SCM Agreement that the investigating authority must take into account in an administrative review “positive information substantiating the need for a review.” Such information could relate to developments with respect to the subsidy, privatization at arm’s length and for fair market value, or some other information. The “same person” method impedes the ITA from complying with its obligation to examine whether a countervailable “benefit” continues to exist in a firm subsequent to that firm’s change in ownership. Therefore, we find that the “same person” method, as such, is inconsistent with…the SCM Agreement

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Decision. The Appellate Body found that in countervailing duty actions, national administrative agencies must consider a broad range of criteria on a case-by-case basis in determining whether prior subsidies to a former government-owned company have “passed through” to the newly privatized company. The “same person” test used by the U.S. Department of Commerce violated the SCM Agreement.

Comment. In 2003, the ITA announced a new rule based on the presumption that a government subsidy can benefit a company over a period of time, corresponding to the useful life of the assets. However, the presumption is rebuttable if it can be shown that the government sold its ownership of all or substantially all of a company or its assets, retaining no control, and that the sale was an arm’s-length transaction for fair market value.

Case Questions

1. What is “privatization” and how might it affect a subsidies case?

2. Why did the ITA conclude that the EC steel mills were the “same legal person”?

3. What factors should be considered in determining whether the European mills were still benefiting from earlier subsidies?

JUDICIAL REVIEW IN INTERNATIONAL TRADE CASES

Decisions of the ITA or ITC in both countervailing duty cases and antidumping duty cases are reviewable in the U.S. Court of International Trade if they are final decisions or if they are negative determinations. A negative determination is a decision by the agency either to not initiate an investigation or that a material injury does not exist. If an antidumping determination involves Canadian or Mexican goods, appeals may be made to a binational arbitration panel established under NAFTA.

CONCLUSION

Most readers are accustomed to hearing arguments in the news, television, and popular press about free trade versus protectionism. The debates seem to be especially vociferous as national elections approach, whether in the United States or elsewhere in the world. Other readers have had the opportunity to study the issues more academically, perhaps in courses in economics. This chapter, however, looked at the issues of free trade and protectionism from a purely legal perspective. We examined the tools, administrative procedures, and remedies available at the international level, through the WTO, and under American law, for dealing with (1) increased imports that threaten to injure a domestic industry and (2) unfair trade.

Anyone interested in additional reading on the law or economics of international trade from a U.S. perspective should consider using the reports and publications of the U.S. International Trade Commission. Readers interested in knowing more about bringing and handling unfair trade actions in the United States should consult the Antidumping and Countervailing Duty Handbook, published by the International Trade Commission (latest edition). The text is an excellent summary and informal resource for business. Another excellent source of information from the ITC is The Year in Trade: Operation of the Trade Agreements Program (latest edition). For statistical data on unfair import cases, see Import Injury Investigations Case Statistics (latest edition). All three reports are available on the Internet.

According to WTO data from 1995 through 2009, the United States has reported having initiated more countervailing duty investigations (102 total) than any other country, followed by the European Union (54), Canada (24), and South Africa (13). Worldwide, more countervailing duty actions are brought against products from India (47) than any other country, followed by China (37) and Korea (17). Eleven countervailing duty actions were brought against the United States.

The countries that report the greatest number of antidumping investigations during those years are India (596), the United States (440), and the European Union (406). Worldwide, almost four times as many antidumping actions are brought against producers from China than any other country (followed by Korea, the United States, and Chinese Taipei).

Combined, all nations reported having brought 209 safeguard actions from 1995 through 2009. The United States initiated no global safeguard actions during the years from 2002 through 2009.

A 2009 report of the International Trade Commission discusses the economic impact of U.S. import restrictions and uses an economic model to estimate what would happen if all significant U.S. trade barriers were removed in the most protected U.S. industries (beef; canned tuna; dairy products; ethyl alcohol; sugar; tobacco; food and agricultural products; textiles and apparel from China, Vietnam, and certain non-WTO member countries; footwear and leather products; glass; watches; ball and roller bearings; and ceramic wall and floor tile). The ITC concluded that,

“[P]ublic and private consumption would increase by about $4.6 billion annually by 2013 if all significant restraints quantified in this report were unilaterally removed. Exports would expand by $5.5 billion and imports by $13.1 billion.” [The Economic Effects of Significant U.S. Import Restraints, Sixth Update, USITC Pub. 4094, August 2009.]

Chapter Summary

1. The terms “safeguard,” “import relief,” and “adjustments to imports” all refer to the WTO-recognized rights of a nation to protect a domestic industry from increasing foreign imports.

2. The WTO Agreement on Safeguards provides that a member may apply a temporary safeguard measure (e.g., increase tariffs) to a product only if that product “is being imported in such increased quantities and under such conditions as to cause or threaten to cause serious injury to the domestic industry that produces like or directly competitive products.” WTO safeguards are global safeguards, meaning that they must be applied to imports of specific products without regard to the country of origin.

3. In the United States, safeguard actions are investigated by the International Trade Commission, an independent agency of government, and its recommendations go to the president. The willingness of the president to protect an industry depends on national interests as well as the president’s own economic and trade philosophies. Special safeguard actions apply to imports from China.

4. Trade adjustment assistance is available to workers, firms, and farmers whose jobs are lost to foreign imports or by the relocation of factories to foreign countries.

5. Dumping is the unfair trade practice of selling goods in a foreign country for less than the normal value of like products in the home market. It is a form of international price discrimination by exporters. National laws and practices on antidumping must follow the basic framework of the WTO Agreement on Antidumping. Antidumping duties can only be imposed on dumped products by the country of import where the dumping causes or threatens material injury to a domestic industry producing like products. Much of the litigation in this area involves determining normal value and the calculation of the dumping margin. In the United States, the International Trade Administration determines the dumping margin, and the International Trade Commission determines if it caused material injury.

6. A subsidy is a financial contribution or benefit conferred by a government to a domestic firm or firms, directly or indirectly, to achieve some industrial, economic, or social objective. Subsidies that are prohibited include export subsidies, import substitution subsidies, and adverse effects subsidies. The WTO Agreement on Subsidies and Countervailing Measures permits the country of import to impose countervailing duties on illegally subsidized imports to offset the value of the benefit.

7. In 2007, for the first time since 1984, the Department of Commerce reversed its policy and began applying the U.S. countervailing duty law to non-market economy countries, including China. This change in policy was due to the growing influx of Chinese imports into the United States, the increasing privatization of Chinese firms, and demands from members of Congress to stop Chinese subsidies.

8. Throughout the area of unfair trade law, the decisions of the WTO Appellate Body in Geneva, Switzerland, are becoming increasingly important. In several cases, the United States has had to reform or repeal its laws and administrative practices to comply with WTO rules.

9. Books and articles on the economics of dumping and subsidies could fill entire libraries. Readers interested in this area should consider furthering their theoretical study of international economics or the economics of international trade.

Key Terms

import competition 338

unfair trade 338

safeguards against injury 339

escape clause 339

global safeguards 342

trade compensation 342

import relief 343

market disruption 345

trade adjustment assistance 346

dumping 347

antidumping laws 347

normal value 348

export price 348

dumping margin 348

like products 348

market viability 351

material injury 351

non-market economy (NME) 352

surrogate normal value 352

market-oriented exporter 352

market-oriented industry 353

subsidy 355

specific subsidy 356

prohibited subsidy 356

export subsidy 356

import substitution subsidy 356

actionable subsidy 356

adverse effects subsidy 356

upstream subsidy 357

countervailing duty 357

Questions and Case Problems

1. What do you think of the results of the USITC report, The Economic Effects of Significant U.S. Import Restraints, Sixth Update, cited in the chapter conclusion? Considering the net effect of import restraints on the volume of imports and exports, and considering the costs incurred in administering all import restraint laws, do you have an opinion of their effectiveness?

2. In this chapter we discussed the U.S.-China Relations Act of 2000 and the authority granted to the ITC and to the president to deal with Chinese imports that cause market disruption to U.S. industry. We gave brief examples of the positions of both President Bush and President Obama. Investigate the positions that each president took on U.S.-China trade relations and in particular their use of the market disruption statute to protect U.S. firms. From your outside reading, what do you think are the arguments for and against imposing additional duties on Chinese imports? Assume that some tire brands, perhaps Michelin or Goodyear, have a better perceived reputation than imported Chinese tires and as a result are able to command a higher retail price. If the price of Chinese tires increases, what do you think might happen to the price of the “quality” brands? How would an economist address these questions? What have you learned about the economic, political, and foreign policy implications?

3. What makes an import practice “unfair”? What remedies are available under U.S. law to protect domestic industries from unfair import competition?

4. Describe the different functions of the ITA and the ITC in regulating import competition.

5. The plaintiff, Smith Corona, was the last remaining manufacturer of portable electric typewriters in the United States. An action was brought to challenge the method used by the International Trade Administration to determine whether the Japanese typewriter companies Brother and Silver Seiko had engaged in dumping in the United States. The typewriters in question were sold in Japan (the home market) under different circumstances of sale than in the United States. In Japan, Silver Seiko provided volume rebates to its customers based on total sales of all merchandise sold. Brother incurred advertising expenses in Japan, as well as expenditures for accessories that accompany typewriters sold in Japan but not in the United States. The ITA subtracted these amounts from foreign market value in calculating the dumping margin. Was the ITA correct? See Smith-Corona Group v. United States, 713 F.2d 1568 (Fed. Cir. 1983).

6. The American Grape Growers alleged that imports of wine from France and Italy were being subsidized and sold in the United States at less than fair value. The ITC’s preliminary review found no reasonable indication that a U.S. industry was threatened with material injury by reason of those imports. The American growers said the ITC decision did not accumulate the imports from France and Italy as it should have done. It instead had considered the two products different because the French wines were primarily white wines, and the Italian wines were primarily red and effervescent. The growers also said the ITC was wrong to base its decision on whether an injury had been proved, as opposed to whether there was a possibility of injury. Do you agree with the grape growers that the ITC’s preliminary decision was wrong?

7. Plaintiff, Cabot Corporation, is contesting the International Trade Administration’s finding that the Mexican government’s provision of carbon black feedstock and natural gas to Mexican producers at below-market prices did not constitute a countervailable subsidy. Carbon black feedstock and natural gas are used in the production of paints, inks, plastics, and carbon paper. The feedstock is a by-product of crude oil and sold in Mexico through PEMEX, the government-owned oil company. Pursuant to a comprehensive economic development plan, PEMEX supplied the feedstock and natural gas at below-market prices to two Mexican producers of carbon black. The plaintiff, a U.S. producer of carbon black, contends that under U.S. law the actions of the Mexican government amount to a countervailable domestic subsidy. What is the correct legal test to determine if the supply of feedstock to Mexican manufacturers was a countervailable domestic subsidy? Cabot Corp. v. United States, 620 F. Supp. 722 (Ct. Int’l Trade 1985).

Managerial Implications

Your firm manufactures optic transistors (OTs), which are a component of personal computers. U.S. firms control 60 percent of the U.S. market for OTs. The market has done well overall, but recently, Japanese manufacturers of computers have increased their market share. Over the past two years, the Japanese have been exporting OTs to the United States in larger quantities. You have noticed that in the past two years your firm’s share of the U.S. market for OTs has dropped from more than 25 percent to less than 20 percent. In addition, your firm’s total sales have declined, its inventories are at their highest levels, and you have had to postpone hiring new employees. You have been informed by one of your better customers that it can purchase imported OTs for $0.95 each, ex factory, or $1.00, CIF American port. Your U.S. price has been $1.20, FOB your factory, with your costs at $0.90. The same OTs are sold to Japanese computer firms at $1.15. Furthermore, you have learned that the Japanese government assists OT manufacturers by rebating the value-added tax normally assessed on all products manufactured in Japan.

To complicate your problems, you have experienced difficulty cracking export markets. You have noticed that countries in which personal computers are now being assembled, such as Brazil, Korea, and Taiwan, have restricted your firm’s imports through a maze of complex regulations. These regulations require that you disclose important manufacturing and design techniques before import licenses will be granted. You are also concerned that your design patents will not be protected there, because Korean patent protection laws are not enforced. Korea has imposed quotas on OTs that make it virtually impossible to export to that market.

What remedies are available to your firm under U.S. law? What factors (economic, political, or other) will affect the outcome of the case? Discuss.

Ethical Considerations

Your firm is a paper converter. It converts paperboard into various articles used in homes and restaurants for food preparation, sale, and storage. Its products include pizza boxes, ice cream boxes, bakery and deli boxes, and paper plates as well as boxes and trays used in fast food operations. You have purchased paperboard from both domestic and foreign sources. Recently, a Chinese supplier has begun offering paperboard for sale directly to your firm at extremely low prices—far lower than what you have been paying domestically. One of your colleagues at your firm called the offer “too good to be true.” What information do you think you need before committing to a purchase? If it turns out that the products are being “dumped” in the U.S. market, what would be the result? What might be the objective of the exporter in this case? Do you think that it is fair or unfair for an exporter to dump its goods in a foreign market? Evaluate the statement, “Selling at a low price can’t be unfair.”

(Schaffer 338)

Schaffer, Agusti, Dhooge, Earle. International Business Law and Its Environment, 8th Edition. South-Western, 2011-01-01. .

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: Imports, Customs, and Tariff

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aw

Importing is the process of entering goods into the customs territory of a country. The study of importing should not be approached from the perspective of an isolated transaction. Rather, importing should be viewed as an integral part of a global company’s operations. For instance, a chemical company might find that raw materials can be sourced from foreign suppliers at a net cost far less than if purchased at home. A leading apparel designer might ship garments to the United States that had been assembled in Honduras, from parts of clothing that were cut and sewn at plants in Hong

K

ong, from fabric that had been woven in China. An automobile company might ship cars to the United States from assembly plants in Mexico that used component parts sourced from Japan or Europe. A Japanese-owned electronics company might assemble televisions in the Caribbean using both Japanese and U.S. parts, with the finished products shipped back to U.S. markets. A large retailer might import foreign-made consumer goods, such as toys or appliances, because they are cheaper from overseas sources. U.S. distributors of Swiss watches,

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anish cheese, or French wine might import these foreign brands because customers perceive them to be of superior quality. Each of these companies views the operation of their firm in a global context, and they are aware that their global strategy will be affected by the customs and tariff laws applicable to their products as these goods cross national borders.

Whereas the preceding chapters discussed the process by which nations regulate international trade, this chapter focuses on the specific problems of importing goods into the United States. It examines U.S. regulations governing the admission of goods into the country, the calculation of import duties, tariff preferences for developing countries, the marking requirements for goods, and the use of many duty-saving devices, such as foreign trade zones. The chapter begins with an explanation of how imports into the United States are supervised by the U.S.

B

ureau of Customs and Border Protection and how the customs and tariff laws are administered.

THE ADMINISTRATION OF CUST

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S AND TARIFF LAWS

The customs and tariff laws of the United States are enacted by the U.S. Congress and are implemented and enforced by the U.S. Bureau of Customs and Border Protection, referred to in this book as U.S. Customs or simply Customs. Customs is an agency within the Department of Homeland Security and is headed by the Commissioner of Customs. The creation of the Department of Homeland Security in 2

00

3 was a part of the largest reorganization of the American government in over fifty years. The Bureau of Customs and Border Protection was created by merging the functions related to border security that had previously been handled by the Department of Agriculture, the Immigration and Naturalization Service, the Border Patrol, and U.S. Customs (formerly a part of the Department of the Treasury). The agency’s duties are to prevent terrorists and terrorist weapons from entering the United States, enforce border security, assess and collect the tariff revenue of the United States, enforce the customs laws, which includes regulating the entry of products under quota or embargo, enforce the labeling statutes, supervise exports, administer duty-free zones, and perform other functions. As a law enforcement agency, U.S. Customs combats smuggling of narcotics and contraband and investigates tariff fraud cases. Customs has the authority to bar the entry of goods that violate patent, trademark, or copyright laws. The agency is responsible for the administration of customs laws throughout the customs territory of the United States, which includes Puerto Rico. In addition, U.S. Customs officers are assigned to U.S. embassies in many foreign countries to assist in the administration of U.S. customs laws.

Customs is divided into seven geographic regions, each headed by a regional commissioner. The regions are further divided into districts, each headed by a district director. Customs offices are located at the ports of entry, including major seaports, airports, inland ports, and border crossings. Within each district are field import specialists, who make initial determinations as to the entry of goods. They can seek advice from national import specialists. Some officers are specialists in particular types of products, such as textiles. The district director supervises all imports within the district and makes sure that imported goods are entered in accordance with the rules of the agency and decisions of the courts.

The Formal Entry

The formal entry refers to the administrative process required to import goods into the customs territory of a country. Goods have officially “entered” the United States only when the following requirements have been met.

1. The goods have arrived at a U.S. “port of entry.”

2. The goods are not of a type that is not permitted entry or from an embargoed country.

3. Delivery is authorized by Customs after inspection and release.

4. Estimated duties have been paid or a customs bond posted.

The process begins upon the arrival of the merchandise at a U.S. port of entry. Goods not processed for entry within fifteen days are sent to a warehouse as “unclaimed freight.” The goods may be entered by the owner, purchaser, consignee (the party to whom the goods are shipped or to be delivered), or licensed customs broker. A customs broker is an authorized agent, licensed by federal law, to act for and on behalf of importers in making entry of goods. (A broker is not needed to import goods for personal use.) Over 90 percent of all entries are made by customs brokers. A customs broker must possess a written power of attorney from the party making entry. Nonresident individuals and foreign corporations may make entry, but they are bound by much stricter rules. The entry process is not merely transporting the goods into the United States; it includes the filing of customs documents and the payment of duties.

Required Documentation.

When goods are entered, the entry documents must be filed within five days. The documents necessary to enter goods generally include the following items:

1. An entry manifest or merchandise release form (see the Entry/Immediate Delivery Form in Exhibit 12.1)

Exhibit 12.1: Entry/Immediate Delivery Form

2. U.S. Customs Entry Summary Form (Exhibit 12.2)

Exhibit 12.2: Entry Summary Form

3. Proof of the right to make entry (a bill of lading, air waybill, or carrier’s certificate)

4. The commercial invoice obtained from the seller (or a pro forma invoice, if the commercial invoice is temporarily delayed by the seller)

5. Packing slips to identify the contents of cartons

6. Other documents required by special regulations (e.g., certificate of origin, quota visa, textile declaration, etc.)

The Commercial Invoice.

A seller must provide a separate invoice for each commercial shipment entering the United States. The commercial invoice is required for all shipments intended for sale or commercial use in the United States. The invoice must provide all pertinent information about the shipment, in English, and be signed by the seller. One invoice can be used for installment shipments to the same consignee if the shipments arrive within ten days of each other. The invoice must include the following information:

• Names of the port of shipment and the destined port of entry

• Name of buyer and seller or consignee

• Common or trade name for the goods and their detailed description

• Country of origin

• Currency of payment

• Quantity and weight of the goods shipped

• Value of the goods accurately and correctly stated, including a breakdown of all itemized charges such as freight, insurance, packing costs, the costs of containers, any rebates and commissions paid or payable, and the value of any production assist

• A packing list stating in detail what merchandise is in each individual package

•

Special

information for certain classes of merchandise (e.g., bedspreads must indicate whether they contain any embroidery, lace, braid, or other trimming)

The Entry Summary and Immediate Delivery Forms.

Within ten working days, the importer must file these completed documents with Customs at the port of entry. The information on the form is used to determine the amount of duties owed, to gather import statistics, and to determine if the goods conform to other U.S. regulations.

Payment of Duties.

If import duties are assessed on the goods by U.S. Customs, the importer must deposit estimated duties with Customs at the time of filing the entry documents or the entry summary form. The duties must be in an amount determined by U.S. Customs, pending a final calculation of the amount actually owed. Payment to a customs broker does not relieve the importer of liability to pay the duties. The liability for duties constitutes a personal debt of the importer, and a lien attaches to the merchandise. In lieu of paying duties immediately, an importer may post a customs bond. This is more convenient for companies needing immediate delivery of their goods. A customs bond can be purchased for a single shipment or for all shipments over the course of a year and up to the amount stated in the bond. The purpose of the bond is to ensure the payment of duties on final calculation. In some cases, goods can be released for transportation or storage in-bond, meaning that the payments of duties are suspended until the goods are released for sale or use in the United States. There is no liability for duties on unordered or unclaimed merchandise.

Informal Entries.

Personal and some smaller commercial shipments valued at $2,000 or less may be cleared through an informal entry process. In this process, a bond is not required for entry, and import duties are payable immediately at the time of entry. Informal entries may be processed through the U.S. Postal Service. The letter carrier acts as the agent for U.S. Customs for the purpose of collecting import duties.

This practice has several advantages. Postal rates can be far less for smaller packages than commercial airfreight, and the entry process is quicker and less expensive, with no customs broker needed. The documentation and marking requirements are still strict, however, and the importer should check with the postal service before attempting a postal entry. A commercial invoice must accompany the shipment. In addition, many products have a $250 limit on postal entries; these include furniture, flowers, textiles, leather goods, footwear, toys, games, and many other items. Wool products and wearing apparel from the Pacific Rim countries require a formal customs entry regardless of value. If a mail article is found to contain merchandise subject to an import duty and the article is not accompanied by a customs declaration and invoice, it is subject to seizure and forfeiture.

Electronic Entry Processing.

In the late 1990s, Customs instituted a paperless entry process, known as the Automated Commercial System. It is designed to reduce costs to business and government and to speed the entry process. The system allows entry documents to be filed electronically through an automated hook-up between importers, customs brokers, and Customs via the Automated Broker Interface. Many companies, primarily the largest and more sophisticated importers and brokers, are already filing electronically.

Remote Location Filing.

Until recently, entry processing had to take place at the port where the goods were located. Thus, importers had to rely on the services of a broker at the port of entry, even if the goods were being entered in a distant location. Large importers who move goods through different ports asked Congress to permit entry processing from remote locations. The Remote Location Filing system allows brokers in all parts of the country to make remote entries at distant ports.

Liquidation and Protest

In a normal import transaction, assuming no errors or penalties are at issue, the entry will be liquidated. Liquidation is the final computation and assessment of the applicable duty on entered goods by Customs. This “closes the book,” making the entry complete. If Customs accepts the entry as submitted on the importer’s documents, liquidation occurs immediately. However, when Customs at the port of entry determines that additional duties are owed, a notice of adjustment is sent to the importer. The importer must respond to the notice, or the duty will be assessed as corrected. If a question or dispute arises concerning the goods themselves, as in the case of technical or unusual products, or in complex cases, the case may be referred to an import specialist familiar with that type of product. Either the importer or Customs officials may seek internal advice from the agency’s headquarters. Officially, the liquidation becomes effective, and the entry is closed, when it is posted at the “customs house” at the port of entry. A courtesy notice is sent to importers advising them of the liquidation, although this notice is not legally effective. If actual duties owed exceed the estimated duties paid at the time of entry, the importer must pay them within fifteen days of the posting of the notice of liquidation.

Time Limits on Liquidation.

Liquidation must occur within one year of entry. The time can be extended for good cause. An entry not liquidated within one year is deemed liquidated by operation of law. Under a deemed liquidation, the goods are dutied at the rate accepted on the entry summary form. A liquidation can be reopened within two years if there is evidence to suspect that the importer committed fraud.

Protesting Liquidations.

An importer that wants to dispute a liquidation made by Customs may file a protest with Customs at the port where the goods were entered within ninety days. An importer may not file a protest where no change was made by Customs to the entry as filed by the importer. Customs has thirty days to respond in cases where the goods have been denied entry; otherwise they have two years to act. Appeals can be made to Customs headquarters in Washington, D.C.

Judicial Review

of Protests.

If Customs denies a protest—which is what usually happens—the importer may seek judicial review in the Court of International Trade. All duties assessed must first be paid, and the appeal must be filed within 180 days. The Court of International Trade is a specialized federal court located in New York City. Appeals from the Court of International Trade are made to the U.S. Court of Appeals for the Federal Circuit in Washington, D.C.

Enforcement and Penalties

The Bureau of Customs and Border Protection is a law enforcement agency charged with enforcing the tariff laws of the United States. U.S. Customs has broad powers to establish regulations, carry out investigations, and impose penalties. All care must be used in complying with customs requirements, and many experienced importers will tell you that they would no sooner make an error on a customs form than they would on their own tax returns.

The basic enforcement and civil penalty provisions of the customs laws are found in Title 19, Section 1592. The offenses set out here are civil violations calling for civil penalties imposed administratively by Customs. Criminal violations are addressed elsewhere in the U.S. Criminal Code. Section 1592 begins by setting out an importer’s basic responsibility: “No person may enter or attempt to enter any merchandise into the United States by means of any written document, electronic transmission of information, oral statement, or other act that is both material and false or which omits any material information affecting the entry.”

Making Materially False Statements to Customs.

An act or statement is “material” if it refers to the identity, quality, value, source, or country of origin of the merchandise, or if it affects the rate of duty charged or the item’s right to be imported into the United States. For instance, falsely stating that cigars of Cuban origin are from Honduras might allow them to illegally pass through customs when they otherwise would be denied entry, and stating that a textile product is decorated with embroidery, when it actually is not, might mean a considerable decrease in the lawful rate of duty.

A false statement or omission can be material even if it does not actually cause a change in the rate of duty. Identifying an imported fabric as “

10

0 percent cotton” when in fact it is made of a blend of cotton and silk would be material even though it may or may not actually result in a change in the rate of duty collected. The statement or omission must also be false. The violation occurs whether the false statement or omission was made intentionally or negligently. There is no violation if the falsity resulted from simple clerical errors or reasonable mistakes of fact outside the control of the importer (such as where a foreign supplier unexpectedly includes merchandise in a sealed container that you were not aware was being shipped to you, and you had no way to find out) as long as the errors are not part of a pattern of negligent conduct. The penalty, however, does depend on whether the offense resulted from negligence, gross negligence, or fraud.

Negligent Violations.

A negligent violation is one in which the importer fails to use reasonable care, skill, and competence to ensure that all customs documents and statements are materially correct and all laws are complied with. It might result because the importer failed to accurately ascertain the facts or information required by Customs when making an entry. It could also result from a misinterpretation of customs regulations or a mistake in completing the customs documents. Negligence penalties can seem pretty severe: If duty has been lost, the penalty can be up to two times the loss of duty, but no more than the value of the goods. If no duty is lost, then the penalty can be as high as

20

percent of the value of the goods, depending on whether there were mitigating or aggravating circumstances.

In the following case, United States v. Golden Ship Trading Co., the importer was found negligent in misstating the country of origin of T-shirts even though she based her information on assurances made by her supplier.

Gross Negligence.

An importer commits gross negligence if there is “clear and convincing evidence” that the act or omission was done with actual knowledge or reckless disregard for the relevant facts and with disregard for the importer’s obligations under the law. The penalty is approximately twice that for negligent violations.

Civil Fraud.

Customs fraud is far more serious than negligence. A fraudulent violation exists where there is “clear and convincing evidence” that the importer knowingly made a materially false statement or omission while entering or attempting to enter goods into the United States. This might include intentionally giving a phony description of the goods being imported, understating their value by submitting a fake seller’s invoice or by concealing money paid to the seller, or altering the country of origin listed on a document. Although the act must have been done knowingly, it does not matter whether the importer intended to evade paying import duties. According to Customs guidelines, the agency will normally seek a penalty equal to 100 percent of the value of the goods, reduced to five to eight times the total loss of duty for mitigating circumstances. Where the fraud did not result in a loss of duty to the government, the minimum penalty sought will be 50 percent of the value of the goods to a maximum of 80 percent. Even greater penalties may be imposed where there has been an egregious violation, a risk to public health or safety, or the presence of aggravating factors. In no case may the penalty exceed the value of the merchandise. In many cases, Customs may seize the merchandise and either have it destroyed or sold at auction.

Crimes.

Criminal penalties for customs fraud and smuggling are set out in Title 18, Chapter 27, of the United States Code specifies a range of criminal activities, including the use of fraudulent customs documents, making false statements to a Customs officer, smuggling, conspiracy, money laundering, and many other acts. The law provides a maximum sentence of two years’ imprisonment, a fine, or both, for each violation. Anyone who willfully, and with the intent to defraud the United States, smuggles or attempts to smuggle goods into the country can receive a five-year prison sentence. Special criminal offenses apply to drug smuggling and to travelers entering the United States with merchandise in their baggage or on their person.

United States v. Golden Ship Trading Co.

2001 WL 65751 (2001) Court of International Trade

BACKGROUND AND FACTS

J. Wu entered three shipments of T-shirts purchased from Hui, who claimed that he operated a factory in the

Dominica

n Republic. Hui furnished all the relevant information necessary for the importer’s custom house broker to prepare the import document and to obtain a visa permit for entry of wearing apparel into the United States. Wu signed the entry papers stating that the country of origin of the T-shirts was the Dominican Republic. Customs discovered that Hui produced the body of the T-shirts in China and shipped them to the Dominican Republic, where sleeves were attached and “Made in Dominican Republic” labels inserted. The finished shirts were then transshipped to the United States. According to law, merely attaching the sleeves did not make the shirts a product of the Dominican Republic. Chinese-made shirts could not have been imported without a textile visa, which Hui may not have been able to obtain. The government alleged that Wu acted without due care in determining the country of origin and sought penalties of $44,000. Wu did not dispute that the country of origin was China but denied that she was negligent and claimed that Hui had duped her.

BARZ

IL

AYJ.

Section 1592(e) describes the burden of proof that each side bears in a penalty action based on negligence. The United States bears the burden of establishing that the material false act or omission occurred; the burden then shifts to the defendant to demonstrate that the act did not occur as a result of negligence. See 19 U.S.C. §1592(e)(4). In this action, Customs has adequately demonstrated that the material false act occurred.

Since the court holds that the statements on the entry papers were both material and false, the only remaining issue is whether Ms. Wu has carried her burden that “the act or omission did not occur as a result of negligence.” To decide if the mismarking was the result of Ms. Wu’s negligence the court must examine the facts and circumstances to determine if Ms. Wu exercised reasonable care under the circumstances.

Ms. Wu admits she relied on the information provided by the exporter and accepted his representations that the Dominican Republic was the country of origin of the teeshirts because “all the documents that the exporter provided prior to entry stated the country of origin was the Dominican Republic.” Further, she claims that she was the victim of the exporter’s fraudulent scheme which was so elaborate that even Customs had difficulty discovering it. Ms. Wu points out that the exporter did have a t-shirt factory in the Dominican Republic and that the factory did perform some manufacturing operations on the imported t-shirts. Ms. Wu also claims “figuring out which (t-shirts) qualified as country of origin Dominican Republic and which did not required an entire team of Customs investigators, special agents and import specialists. Obviously, the exporter’s fraud in this case was well-concealed.” Furthermore, she contends, if Customs had difficulty investigating and uncovering the exporter’s falsifications, how could Ms. Wu, with far fewer resources and less expertise, be expected to know that the entry papers falsely reflected the country of origin of the imported t-shirts. Therefore, Ms. Wu claims, shewas justified in relying on the exporter’s entry information.

The court finds that Ms. Wu failed to exercise reasonable care because she failed to verify the information contained in the entry documents. Under the regulation’s definition of reasonable care, Ms. Wu had the responsibility to at least undertake an effort to verify the information on the entry documents. There is a distinct difference between legitimately attempting to verify the entry information and blindly relying on the exporter’s assertions. Had Ms. Wu inquired as to the origin of the imported t-shirts or, at minimum, attempted to check the credentials and business operations of the exporter, she could make an argument that she attempted to exercise reasonable care and competence to ensure that the statements on the entry documents were accurate. Instead, Ms. Wu applies circular reasoning to prove she was not negligent. She assumes she would not have been able to discover that the exporter was misrepresenting the county of origin and therefore was not negligent even though she made no attempt to verify. The critical defect with Ms. Wu’s argument is that it removes the reasonable care element from the negligence standard. The exercise of reasonable care may not have guaranteed success, but the failure to attempt any verification undercuts the argument that she would have been unable to determine the truth.

Ms. Wu failed to “exercise” reasonable care because she utterly failed to attempt to verify the exporter’s information. Indeed, Ms. Wu admits, and the evidence is uncontraverted, that she relied solely on the word of the exporter.

Q. What information did you rely on when you signed this document that indicates that the single country of origin of the imported items was the Dominican Republic?

A. I believe [sic] Pedro. He said he sent me all the documents and the documents said it’s made in the Dominican Republic so I just signed them.

Furthermore, Ms. Wu openly admits she did not inquire at all about the origin of the imported merchandise.

Q. Did you discuss with Mr. Hui (the exporter) where the fabrics from the t-shirts were made?

A. I never asked. I don’t [sic] know how to ask. I never asked it.

Although it is apparent Ms. Wu did not directly research the authenticity of the exporter’s claims, she argues that she employed the services of a licensed customs house broker and relied on the broker’s expertise to properly prepare the import documents. However, Ms. Wu did not attempt to verify or ascertain the correctness of the information prepared by the broker.

Q. Did you discuss with the broker where he got the information from?

A. I did not discuss it with him.

Even though Ms. Wu did not attempt to verify the country of origin, she still signed and certified the accuracy of the information contained in the entry documents. Ms. Wu’s reliance on the exporter and the broker does not remove the obligation to exercise reasonable care and competence to ensure that the statements made on the entry documents were correct.

The court finds that Ms. Wu’s failure to attempt to verify the entry document information shows she did not act with reasonable care and did, therefore, attempt to negligently introduce merchandise into the commerce of the United States in violation of 19 U.S.C. §1592(a)(l)(A) and, therefore, must pay a civil penalty for her negligence pursuant to 19 U.S.C. §1592(c)(3)(B).

With regard to the amount of the penalty, the court directs the parties to attempt to settle the matter by consultation guided by the court’s opinions in United States v. Complex Machines Works Co., 83 F. Supp. 2d 1

30

7 (1999) and United States v. Modes, Inc., 826 F. Supp. 504 (1990) regarding mitigation.

Decision. Wu did not exercise reasonable care because she failed to verify the information contained in the entry documents. Customs could assess a penalty that took into account the mitigating circumstances of the case. Once the government proved the false act occurred, the burden shifted to Ms. Wu to prove that she was not negligent.

Case Questions

1. What was Wu’s motivation in stating that the shirts were made in the Dominican Republic?

2. What is the burden of proof? Must the United States prove that Wu was negligent or must Wu prove that she was not?

3. Can the importer (Wu) rely on the statements of the third party (here, the shirt exporter) to avoid responsibility?

Aggravating and Mitigating Circumstances.

The following are examples of the types of additional factors that Customs will consider in determining the amount of a penalty.

• Aggravating Factors: These include obstructing an investigation, withholding evidence, providing misleading information, prior improper shipments, and illegal transshipments of textiles to hide their actual country of origin.

• Mitigating Factors: These include errors committed by Customs itself that contributed to the violation; erroneous advice from a Customs official; cooperation with the investigation; immediate remedial reaction (e.g., payment of the duty voluntarily and immediately, discharge, or retraining of an offending employee); inexperience in importing (except in fraud cases); or a prior good shipment record. In addition, Customs may consider the ability of the importer to pay the penalty.

Enforced and Informed Compliance.

Customs and Border Protection takes a two-pronged approach to enforcement of the customs laws: enforced compliance and informed compliance. Enforced compliance refers to the active investigation of customs violations and the prosecution of violators. Informed compliance refers to “softer” mechanisms designed to place the burden of voluntary compliance on importers. Compliance with the customs laws is much like compliance with the income tax laws. Unless the majority of U.S. importers, like taxpayers, voluntarily comply with the customs laws, enforcement will be impossible. Congress recognized this when it passed the Customs Modernization and Informed Compliance Act of 1993 (called the Mod Act). It introduced the doctrine of informed compliance, which shifted to the importer a major responsibility to comply with all customs laws and regulations. It requires that importers, customs brokers, and carriers use reasonable care in complying with the law, in handling all import transactions, and in preparing all documentation for entered goods. Reasonable care means more than simply being careful. It means that those handling import transactions must be properly trained and that companies must establish internal controls over import operations to ensure compliance. When requirements are not understood, the importer should consult a licensed broker, customs law attorney, or U.S. Customs itself. Importers are expected to have enough information and knowledge to comply with the law. This includes having accurate information about the type of merchandise being imported, its value and origin, the identity of the seller, and so forth. It also requires importers to have a working knowledge of customs statutes, regulations, and rulings and U.S. Customs procedures.

In order to make informed compliance work, Customs recognizes that it has a responsibility to provide information, advice, technical assistance, and clear regulations to importers. Customs works closely with high-volume importers and those in problem or sensitive industries (e.g., textiles, automobiles, and steel) to assist them in developing their own corporate compliance programs.

The Reasonable Care Checklist.

In 1997, U.S. Customs published a checklist to give smaller and less experienced importers a better understanding of their obligation to use reasonable care (see Exhibit 12.3). Customs understood that a “black-and-white” definition of reasonable care is impossible because the concept depends on individual circumstances. The checklist is not a law or regulation; it merely helps importers to understand what is expected of them. Importers who fail to meet the reasonable care requirements on the checklist may be subjected to penalties for negligence.

Exhibit 12.3: Just How Informed Do You Have to Be? Reasonable Care Checklist for Importers

1. If you have not retained an expert to assist you in complying with U.S. Customs requirements, do you have access to the Customs Regulations (Title 19 of the Code of Federal Regulations), the Harmonized Tariff Schedule of the United States, and the GPO publication Customs Bulletin and Decisions? Do you have access to the Customs Internet Web site, Customs Electronic Bulletin Board, or other research service to permit you to establish reliable procedures and facilitate compliance with customs laws and regulations?

2. Have you consulted with a customs “expert” (e.g., lawyer, broker, accountant, or customs consultant) to assist in preparation of documents and the entry of the merchandise?

3. If you use an expert to assist you in complying with U.S. Customs requirements, have you discussed your importations in advance with that person and have you provided that person with full, complete, and accurate information about the import transactions?

4. Has a responsible and knowledgeable individual within your organization reviewed the customs documentation prepared by you or your expert to ensure that it is full, complete, and accurate?

5. Are identical transactions or merchandise handled differently at different ports or customs offices within the same port? If so, have you brought this to the attention of the appropriate customs officials?

6. Have you established reliable procedures within your organization to ensure that you provide complete and accurate documentation to U.S. Customs?

7. Have you obtained a customs ruling regarding the importation of the merchandise?

8. Do you know the merchandise that you are importing and have you provided a detailed and accurate product description and tariff classification of your merchandise to U.S. Customs? Is a laboratory analysis or special procedure necessary for the classification?

9. Have you consulted the tariff schedules, U.S. Customs’ informed compliance publications, court cases, or U.S. Customs rulings to assist you in describing and classifying the merchandise?

10. If you are claiming a free or special tariff treatment for your merchandise (e.g., GSP, HTS Item 9802, NAFTA, etc.), have you established a reliable program to ensure that you reported the required value information and obtained any required or necessary documentation to support the claim?

11. Do you know the customs value of the imported products? Do you know the “price actually paid or payable” for your merchandise?

12. Do you know the terms of sale; whether there will be rebates, tie-ins, indirect costs, additional payments; whether “assists” were provided, commissions or royalties paid? Have all costs or payments been reported to U.S. Customs? Are amounts actual or estimated? Are you and the supplier “related parties,” and have you disclosed this to U.S. Customs?

13. Have you taken reliable measures to ascertain the correct country of origin for the imported merchandise? Have you consulted with a customs expert regarding the country of origin of the merchandise?

14. Have you accurately communicated the proper country of origin marking requirements to your foreign supplier prior to importation and verified that the merchandise is properly marked upon entry with the correct country of origin?

15. If you are importing textiles or apparel, have you developed reliable procedures to ensure that you have ascertained the correct country of origin and assured yourself that no illegal transshipment (rerouting through a third country for illegal purposes) or false or fraudulent documents or practices were involved? Have you checked the U.S. Treasury’s published list of manufacturers, sellers, and other foreign persons who have been found to have illegally imported textiles and apparel products? If you have obtained your textiles from one of these parties, have you adequately verified the country of origin of the shipment through independent means?

16. Is your merchandise subject to quota/visa requirements and, if so, have you provided or developed a reliable procedure to provide a correct visa for the goods upon entry?

17. Have you determined or established a reliable procedure to permit you to determine whether your merchandise or its packaging bear or use any trademarks or copyrighted matter or are patented and, if so, that you have a legal right to import those items into, and/or use those items in, the United States?

18. If you are importing goods or packaging materials that contain registered copyrighted material, have you checked to ensure that it is authorized and genuine? If you are importing sound recordings of live performances, were the recordings authorized?

19. Have you checked to see that your merchandise complies with other government agency requirements (e.g., FDA, EPA/DOT, CPSC, FTC, Department of Agriculture, etc.) prior to or upon entry and procured any necessary licenses or permits?

20. Have you checked to see if your goods are subject to a Commerce Department dumping or countervailing duty determination and reported that to U.S. Customs?

SOURCE: Excerpted and adapted by the authors from TD-97-96 (1997), United States Customs.

Reporting Errors to Customs before an Investigation.

Congress has enacted a statute to encourage importers to voluntarily report their own possible violations of the customs laws. This is called a prior disclosure. If an importer admits its mistake and informs Customs of a possible violation before learning that it is being investigated, the penalties are limited. The importer must completely disclose the materially false statements or omissions and the circumstances of the violation. Any unpaid duties must be remitted immediately or within thirty days. However, an attorney should be consulted before doing so. Some prior disclosures have reportedly saved companies many millions of dollars in potential fines.

The Statute of Limitations.

The government is barred from bringing any action to collect an import duty after five years from the date of the violation involving negligence or gross negligence, or five years from the date of discovery of a violation involving fraud.

Record-Keeping Requirements.

Importers are required to keep records of all import transactions for five years from the date of entry and to give Customs access to those documents on demand. The records include all documents “normally kept in the ordinary course of business,” including sales contracts, purchase orders, government certificates, letters of credit, internal corporate memoranda, shipping documents, correspondence with suppliers, and any other documents bearing on the entry of the merchandise. It is highly recommended that any corporate importer establish a customs records compliance program to avoid penalties. The willful failure to keep records about the entry is punishable by the lesser of a $100,000 fine or 75 percent of the value of the merchandise. Even negligent record keeping is punishable by fines up to $10,000 or 40 percent of the value of the goods, whichever is less. There is an exception if the records were destroyed by an act of God. Concealment or destruction of records carries an additional $5,000 fine or up to two years’ imprisonment or both. U.S. Customs conducts audits to verify business records. Inspections can take place on reasonable notice to the importer. Documents can be seized by court order.

Judicial Enforcement of Penalty Actions.

In any action to collect a penalty, U.S. Customs acts as plaintiff in bringing suit in the Court of International Trade. Quite often, Customs will ask the court to consider all theories of culpability—negligence, gross negligence, and fraud—hoping to win on one or the other theory. The burden of proof in court depends on the violation. Fraud and gross negligence must be proved by “clear and convincing evidence.” In negligence cases, the government must prove only that the act or omission occurred; the burden then shifts to the defendant-importer to show that it did not occur as a result of negligence.

Binding Rulings

Imagine that you have an opportunity to sell imported women’s boxer shorts to a leading U.S. department store chain. They would like you to quote “your best price.” You learn that some women will wear the boxers as short pants, while others will wear the shorts as underwear. If you underestimate your costs, you will end up eating your shorts on the deal. The problem is that you are not sure whether Customs will consider the boxers to be “outerwear,” which is dutied at almost 18 percent, or “women’s slips and briefs,” which are dutied at less than 12 percent. Importers faced with a situation like this may make a written request for a binding ruling, also called a ruling letter, from Customs in advance of an entry. A binding ruling represents the official position of Customs with respect to the specific transaction for which it was issued. It is binding on Customs personnel until revoked. Customs does not publish public notice in advance of a ruling, and there is no opportunity for the public to comment on the issue.

Rulings are important to importers, especially those dealing in new or unusual merchandise that they have not imported before. They relieve them of the uncertainty of how the product will be treated by Customs or how much duty they will have to pay.

Binding rulings can be even more important where companies are considering the tariff consequences of restructuring their global manufacturing operations. Take another simple example. Assume you are trying to choose between Mexico and China as a site to produce bicycles for sale in the United States. The parts will come from many suppliers around the world. Among all the factors to be considered—labor costs, quality control issues, local tax rates, access to the U.S. market—there are also the tariff consequences. Will there be a difference in the tariff rate if you produce bicycles in China and import the completed bicycles into the United States rather than importing the parts into Mexico, assembling the bicycle there, and shipping to customers in the United States? This requires a working knowledge of complex tariff code provisions. Obtaining a ruling letter from Customs in advance will mean one less surprise later on.

A request for a ruling letter should be submitted in writing. It should contain all relevant information, and in some cases—like the boxer shorts case—the importer should send a sample of the article. The ruling is issued only on the basis of the exact facts given and ensures that the products described will be entered according to the terms set out in the letter. The letter applies only to the importer to whom it is addressed. (You can research ruling letters on the Customs Website.) Most rulings are issued within thirty to sixty days, although especially difficult ones can take up to nine months. Rulings are published in the Customs Bulletin.

Judicial Review

The role of the courts in reviewing the decisions and actions of U.S. Customs depends on whether Customs was involved in formal rulemaking applicable to the public at large or whether it was an informal action, such as the issuance of a binding ruling or an action affecting a single shipment of goods belonging to a single importer.

Judicial Review of Formal Rulemaking.

In United States v. Haggar Apparel Co., 526 U.S. 380, 119 S.Ct. 1392 (1999), Haggar shipped U.S.-made fabric to Mexico where it was cut and sewn into pants, then perma-pressed and returned to the United States for sale. According to U.S statutes (Section 9802 of the U.S. tariff schedules), component parts or materials made in the United States may be shipped to certain foreign plants for assembly and returned to the United States with a partial duty exemption. However, the materials may only be assembled and must not undergo further manufacturing or processing in the foreign country. Customs issued a regulation interpreting the statute, stating that perma-pressing was an additional step in manufacturing and “not incidental to the assembly process.” Customs issued the regulation using a formal rulemaking process (called “notice and comment” rulemaking) so it was applicable to all importers. In other words, as a formal rule it was more than just a ruling regarding a single entry by an individual importer. It was promulgated only after a public comment period, it was published in the Code of Federal Regulations, and it had the “force of law.”

The Supreme Court held for the government, stating that Customs’ decision to define perma-pressing as “not incidental to the assembly process” was perfectly reasonable. The Supreme Court held that courts must give “judicial deference” to the formal regulations of U.S. Customs where those regulations are a “reasonable interpretation” of an ambiguous statute. This is known as “Chevron deference,” taken from the important case of Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 104 S.Ct. 2778 (1984).

Judicial Review of Binding Rulings.

Haggar did not address the scope of judicial review of informal decisions such as binding rulings. These and other routine decisions are made on a case-by-case basis every day—thousands every year—by Customs officials around the country. It might be a binding ruling about the tariff classification of imported merchandise or a decision about an entry when the goods arrive at a U.S. port. If an importer seeks review of a Customs decision in the courts, to what extent will the court give deference to Customs’ decision? Should the court consider that the agency is an expert on customs matters and simply defer to its original decision? Or should the court undertake its own analysis and reach its own decision independent of the agency’s determination? The following U.S. Supreme Court decision, United States v. Mead, defines the scope of judicial review of binding rulings, tariff classifications, and other “informal” day-to-day decisions of Customs.

Pre-importation Judicial Review in Emergency Circumstances.

Normally, an importer cannot seek court review until a shipment has been entered and a protest denied by Customs. Under limited circumstances, an importer may seek review in the courts prior to entry only where extraordinary circumstances could cause irreparable injury to the importers and severe business disruption and substantial costs would result if a decision were not reached. Other cases have stated that if an importer can show that a Customs ruling threatens to “close the importer’s doors,” then review will be permitted in advance of entering the goods.

DUTIABLE STATUS OF GOODS

Tariffs, restraints on imports, and other import controls are applied to goods according to the item’s dutiable status. The dutiable status of goods is determined by (1) the classification of the article (what it is), (2) the customs value of the article, and (3) the country of origin of the article (the country it comes from for purposes of determining the tariff rate or applicability of a quota). An accurate estimate of the duties owed on imports provides information essential for business planning, development of cost estimates, and pricing and marketing decisions.

United States v. Mead Corp.

533 U.S. 218 (2001) United States Supreme Court

BACKGROUND AND FACTS

Mead had imported “day planners” for several years. They had entered duty-free under HTSUS 4820.10. The classification covers “[R]egisters, account books, notebooks, order books, receipt books, letter pads, memorandum pads, diaries and similar articles.” HTSUS 4820.10 has two subcategories. Items in the first, “[d]iaries, notebooks and address books, bound; memorandum pads, letter pads and similar articles,” were subject to a tariff of 4 percent at the time in controversy. Articles in the second, covering “other” items, were free. The planners had been classified in the “other” subcategory. They included a calendar, a section for daily notes, a section for telephone numbers and addresses, and a notepad. The larger models also included a daily planner section, plastic ruler, plastic pouch, credit card holder, and computer diskette holder. A loose-leaf ringed binder held the contents, except for the notepad, which fit into the rear flap of the day planner’s outer cover. In a binding ruling, Customs changed the classification of the planners to “bound diaries” under the first subcategory, with a 4 percent import duty. Mead argued that the day planners were not diaries and were not bound and that the planners should be classified in an “other” subcategory that was duty-free. After entering the goods and paying the duties, Mead filed a protest. When the protest was denied, Mead appealed. The Court of International Trade issued a summary judgment for the government. The Court of Appeals reversed, holding that the planners were not “bound diaries” on the basis of the dictionary meaning of those words. The court held that it owed no deference to Customs’ classification rulings under the Chevron and Haggar court decisions, but was free to decide the classification issue anew as a matter of law. The court noted that those cases involved formal regulations that carried the force of law, while classification rulings apply only to the specific transaction at issue. The U.S. Supreme Court agreed to hear the case.

JUSTICE SOUTER

We agree that a tariff classification has no claim to judicial deference under Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 104 S.Ct. 2778, 81 (1984) there being no indication that Congress intended such a ruling to carry the force of law, but we hold that under Skidmore v. Swift & Co., 323 U.S. 134, 65 S.Ct. 161 (1944), the ruling is eligible to claim respect according to its persuasiveness [most citations omitted].

* * *

“[T]he well-reasoned views of the agencies implementing a statute ‘constitute a body of experience and informed judgment to which courts and litigants may properly resort for guidance,’ Skidmore, and [w]e have long recognized that considerable weight should be accorded to an executive department’s construction of a statutory scheme it Is entrusted to administer…” Chevron. The fair measure of deference to an agency administering its own statute has been understood to vary with circumstances, and courts have looked to the degree of the agency’s care, its consistency, formality, and relative expertness, and to the persuasiveness of the agency’s position…. Justice Jackson summed things up in Skidmore:

The weight [accorded to an administrative] judgment in a particular case will depend upon the thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control.

* * *

There is room at least to raise a Skidmore claim here, where the regulatory scheme is highly detailed, and Customs can bring the benefit of specialized experience to bear on the subtle questions in this case: whether the daily planner with room for brief daily entries falls under “diaries,” when diaries are grouped with “notebooks and address books, bound; memorandum pads, letter pads and similar articles,” HTSUS subheading 4820.10.20; and whether a planner with a ring binding should qualify as “bound,” when a binding may be typified by a book, but also may have “reinforcements or fittings of metal, plastics, etc.,” Harmonized Commodity Description and Coding System Explanatory Notes to Heading 4820. A classification ruling in this situation may therefore at least seek a respect proportional to its “power to persuade,” Skidmore. Such a ruling may surely claim the merit of its writer’s thoroughness, logic, and expertness, its fit with prior interpretations, and any other sources of weight.

* * *

Since the Skidmore assessment called for here ought to be made in the first instance by the Court of Appeals for the Federal Circuit or the CIT, we go no further than to vacate the judgment and remand the case for further proceedings consistent with this opinion. It is so ordered.

Decision. The Court of International Trade and the Court of Appeals for the Federal Circuit must grant a limited degree of deference to the tariff classification ruling letters issued by U.S. Customs, according to the Skidmore standard. The degree of deference depends on the agency’s thoroughness, the validity of its reasoning, its expertise, and its “power to persuade.”

Comment. On remand to the Court of Appeals, the court found Customs’ ruling somewhat “unpersuasive” under the Skidmore standard. Noting that it was the court’s job to determine the meaning of language used in the tariff schedules, the court relied on the dictionary definitions of “bound” and “diary,” and, for a second time, entered a judgment for Mead.

Case Questions

1. When a court reviews a classification ruling, is the court free to disregard the position of Customs and consider all the evidence anew? Must the court give complete deference to Customs’ rulings? What does the court say is the correct standard of review?

2. What was the legal rationale the Supreme Court used in holding for Mead?

3. What about the product—day planners—that gave rise to the appeal? Do you think that a loose leaf “day planner” is a “bound diary”? Could you locate these in the tariff schedules and determine the current rate of duty?

Determining the dutiable status of an article can require importers to negotiate a maze of regulations. For importers who enter a wide variety of products or materials or who enter them from many different countries, the potential for problems increases significantly. For U.S. exporters trying to enter goods into foreign countries, the regulatory headaches can become nightmarish. Lessons learned from importing into one country are not necessarily transferable when importing into another.

In recent years, worldwide efforts have attempted to make customs procedures and import regulations more uniform, more understandable, and easier to follow. Simplified, uniform rules would make it easier for both importers and their foreign suppliers to plan their transactions in advance and to comply with complicated laws and regulations. These efforts are beginning to result in the development of uniform rules for classifying and valuing imports and for determining their country of origin. These include a standardized system for classifying products (officially known as the Harmonized Commodity Description and Coding System), the WTO Agreement on

Customs Valuation

(1994), and the WTO Agreement on

Rules of Origin

(1994).

The Harmonized Tariff Schedule

All goods entering the United States are dutiable unless specifically exempted. Duties and restrictions on imports are based on the exact type and classification of goods being imported. Since 1989, goods entering the United States have been classified according to the Harmonized Tariff Schedule of the United States (HTSUS or HTS). The harmonized system was part of a worldwide effort, spanning nearly two decades, to standardize tariff nomenclature according to the Harmonized Commodity Description and Coding System. Under this uniform system, in effect in most trading nations of the world, all goods are classified by their name, description, or use. Goods that fall into a certain classification in one country will be similarly classified in all countries that follow the harmonized system. Thus, a company that knows the classification of its product in the United States, for example, is easily able to determine the classification of its product in most other countries. The harmonized system does not set the tariff rate, and tariff rates are not necessarily uniform between countries. Tariff rates on goods are set by each nation according to the classification of those goods. The harmonized system was developed by the World Customs Organization, an international organization located in Brussels, representing over 170 nations. In the United States, the HTSUS is maintained by the International Trade Commission and is available online directly or through U.S. Customs and Border Protection.

Using the Harmonized Tariff Schedule.

The HTSUS divides products into approximately 5,000 tariff classifications, ranging from basic commodities and agricultural products to manufactured goods. It is organized into twenty-two sections, covering products from different industries. Sections are broken down into ninety-nine chapters, each covering the commodities, materials, and products of a distinct industry. The chapters are arranged in a progression from crude and natural products such as livestock and agricultural products through advanced manufactured goods such as vehicles and aircraft. The following list provides a few examples:

Chapter 1

Live animals

Chapter 9

Coffee, tea, spices

Chapter 22

Beverages, spirits, vinegar

Chapter 25

Salt, sulfur, earths, and stone

Chapter 30

Pharmaceuticals

Chapter 44

Wood and articles of wood

Chapter 51

Wool, fine or coarse animal hair

Chapter 52

Cotton

Chapter 62

Articles of apparel, accessories not knitted

Chapter 63

Other textile articles, sets, worn clothing

Chapter 76

Aluminum and articles thereof

Chapter 84

Nuclear reactors, boilers, machinery, and mechanical appliances

Chapter 85

Electrical machinery, sound recorders, television image

Chapter 88

Aircraft, spacecraft, parts thereof

Chapter 94

Furniture, bedding, lamps

Chapter 97

Works of art, collectors’ pieces

Chapters 98/99

Reserved for special tariff classifications (e.g., imports that enter the United States only temporarily or for service and repair, etc.)

Chapters are broken down into headings, subheadings, and tariff items. Tariff items are denoted by eight-digit codes. In the United States, the schedules break out to ten digits to allow for compiling of statistical data on imports.

Chapter :

first two digits

Heading :

First four digits

Subheading :

first five or six digits

Tariff items :

first eight digits

Statistical break:

ten digits (the ninth and tenth digit)

Consider the example in Exhibit 12.4 Tents made of synthetic fibers—such as nylon—used for backpacking are classified as item

6306

.22.10. They are found within subheading

6306.22

, for tents of synthetic fibers, heading 6306 for “Tarpaulins, awnings and sunblinds, tents, sails for boats…” and chapter 63 for “Other textile articles.” Countries that use this international coding system have “harmonized” their classifications to six digits at the subheading level. After the first six digits, each country assigns its own numbers.

Exhibit 12.4: Harmonized Tariff Schedule of the United States (2010) (Rev.1)

Heading/Subheading

Stat Suffix

Article Description

Unit of Quantity

Rates of Duty

1
2

General

Special
6306

 

Tarpaulins, awnings and sunblinds; tents; sails for boats, sailboards or landcraft; camping goods:

     Tarpaulins, awnings and sunblinds:

 
 
 
 

6306.11.00

00

          Of cotton

(369)

kg

8.8%

Free (

CA

,IL,

MX

)

4.4% (

JO

)

90%

6306.12.00

00

          Of synthetic fibers

(669)

kg

8.9%

Free (CA,IL,MX)

2.3% (JO)

90%

6306.19.00

 

          Of other textile materials

 

5.2%

Free (CA,E*,IL, MX)

40%

 
10

               Of artificial fibers (669)

kg
 

1.3% (JO)

 
 
20

               Other

(899)

kg
 
 
 
 
 

     Tents:

 
 
 
 

6306.21.00

00
          Of cotton
kg
8.8%
Free (CA,IL,MX) 4.4% (JO)
90%
6306.22
 

          Of synthetic fibers:

 
 
 
 

6306.22.10

00

               Backpacking tents

No. kg

0.

5%

Free (A,CA,E,IL,J,MX)

90%

6306.22.90

 
               Other
 
8.9%
Free (CA,IL,MX)
90%
 
10

                    Screen houses

kg
 
2.3% (JO)
 
 
30

                    Other (669)

kg
 
 
 

6306.29.00

00
          Of other textile materials
kg

3.2%

Free (CA,E*,IL,J*,JO,MX)

40%
 
 

     Sails:

 
 
 
 

6306.31.00

00
          Of synthetic fibers
kg

0.4%

Free (A,CA,E,IL,J,MX)

30%

6306.39.00

00
          Of other textile materials
kg
0.4%
Free (A,CA,E,IL,J,MX)
30%
 
 

     Pneumatic mattresses:

 
 
 
 

6306.41.00

00
          Of cotton
kg

3.8%

Free (CA,IL,JO,MX)

25%

6306.49.00

00
          Of other textile materials
kg
3.8%

Free (A,CA,E,IL,J*,JO,MX)

25%
 
 

     Other:

 
 
 
 

6306.91.00

00
          Of cotton
kg
3.8%

Free (C AIL,JO,MX)

40%

6306.99.00

00
          Of other textile materials
kg
5%

Free (CA,E*,IL,J*,MX) 1.5% (JO)

78.5%

Annotated for Statistical Reporting Purposes

General Notes [edited for student use]

3. Rates of Duty. The rates of duty in the “Rates of Duty” columns designated 1 (“General” and “Special”) and 2 of the tariff schedule apply to goods imported into the customs territory of the United States as hereinafter provided in this note

a) Rate of Duty Column 1.

i) Except as provided in subparagraph (iv) of this paragraph, the rates of duty in column 1 are rates which are applicable to all products other than those of countries enumerated in paragraph (b) of this note. Column 1 is divided into two subcolumns, “General” and “Special,” which are applicable as provided below.

ii) The “General” subcolumn sets forth the general or normal trade relations (NTR) rates which are applicable to products of those countries described in subparagraph (i) above which are not entitled to special tariff treatment as set forth below.

iii) The “Special” subcolumn reflects rates of duty under one or more special tariff treatment programs described in paragraph (c) of this note and identified in parentheses immediately following the duty rate specified in such subcolumn. These rates apply to those products which are properly classified under a provision for which a special rate is indicated and for which all of the legal requirements for eligibility for such program or programs have been met. Where a product is eligible for special treatment under more than one program, the lowest rate of duty provided for any applicable program shall be imposed. Where no special rate of duty is provided for a provision or where the country from which a product otherwise eligible for special treatment was imported is not designated as a beneficiary country under a program appearing with the appropriate provision, the rates of duty in the “General” subcolumn of column 1 shall apply.

vi) Products of Insular Possessions (omitted)

v) Products of the West Bank or Gaza Strip (omitted)

b) Rate of Duty Column 2. Notwithstanding any of the foregoing provisions of this note, the rates of duty shown in Column 2 shall apply to products, whether imported directed or indirectly, of the following countries and areas:

Cuba     North Korea

c) Products Eligible for Special Tariff Treatment.

i) Programs under which special tariff treatment may be provided, and the corresponding symbols for such programs as they are indicated in the “Special” subcolumn, are as follows:

Generalized System of Preferences

A, A* or A+

United States–Australia Free Trade Agreement

AU

Automotive Products Trade Act

B

United States–Bahrain Free Trade Agreement Implementation Act

BH

Agreement on Trade in Civil Aircraft

C

North American Free Trade Agreement:

 

      Goods of Canada, under the terms of general note 12 to this schedule

CA

      Goods of Mexico, under the terms of general note 12 to this schedule

MX

United States–Chile Free Trade Agreement

CL

African Growth and Opportunity Act

D

Caribbean Basin Economic Recovery Act

E or E*

United States–Israel Free Trade Area

IL

Andean Trade Preference Act or

 

      Andean Trade Promotion and Drug Eradication Act

J, J* or J+

United States–Jordan Free Trade Area Implementation Act

JO

Agreement on Trade in Pharmaceutical Products

K

Dominican Republic–Central America–United States

 

      Free Trade Agreement Implementation Act

P or P+

Uruguay Round Concessions on Intermediate

 

      Chemicals for Dyes

L

United States–Caribbean Basin Trade Partnership Act

R

United States–Morocco Free Trade Agreement Implementation Act

MA

United States–Singapore Free Trade Agreement

SG

United States–Oman Free Trade Agreement Implementation Act

OM

United States–Peru Trade Promotion Agreement Implementation Act

PE

After locating the article in the schedule, the importer can determine the tariff rate. The schedule is divided into two columns (see Exhibit 12.4). Column 1 contains a general rate applicable to imports from NTR (formerly MFN) nations, and a special rate applicable to one or more special tariff programs. The special rate applies to goods coming from developing countries under the Generalized System of Preferences, to goods coming from Canada or Mexico under the North American Free Trade Agreement, or to goods imported from the Caribbean Basin or Israel. Column 2 rates are the original Smoot–Hawley rates applicable to non-NTR countries under the Tariff Act of 1930, although few countries fall in this category today.

Tariffs are imposed on imports either on the basis of ad valorem, specific, or compound rates. The most common type of tariff is the ad valorem rate, based on a percentage of the value of the materials or articles imported. A specific rate is a specified amount per unit of weight or measure. A compound rate is a combined ad valorem and specific rate.

The Classification of Goods

Tariff rates are based on an article’s classification. To classify a product, you must know what your product is or how it will be used and where it falls in the tariff schedules. This is not as easy a task as it might seem. The schedules include every kind and category of product on earth. They include consumer goods ranging from “Articles for Christmas festivities and parts thereof” to “Electromechanical domestic appliances”; textile products ranging from “Cotton, not carded or combed, having a staple length under 28.575 mm” to “Men’s or boys’ suits… of worsted wool fabric… having an average fiber diameter of 18.5 microns or less”; industrial equipment ranging from “Bookbinding machinery” to “Nuclear reactors”; and electronic products from “Ballasts for discharge lamps or tubes” to “Laser imaging assemblies.” Finding your product among these is like walking a maze.

The problem is compounded because many products appear to fit into more than one classification. For example, should sleeping bags be classified as “Camping goods,” “Sporting goods,” or as “Articles of bedding and similar furnishing…fitted with springs or stuffed”? This is an area where reasonable minds can differ. Naturally, importers will argue that their products should fall into the classification that carries the lowest tariff rate. U.S. Customs, whose job it is to collect the tariff revenue of the United States, will want to classify the products at the highest rate. (Initially, the importer makes the classification by listing it on the entry form filed with Customs, who must then accept or reject the classification. Of course, the importer is bound by the informed compliance standard to use reasonable care in making its classification.) It is especially difficult for importers to classify a product if they are importing it for the first time or if it is a newly designed product. The problem is complicated by the fact that at any time Customs can “change its mind” and decide to reclassify an article, despite having accepted another classification of the same article in the past.

To illustrate how difficult it is to classify an article, consider the following case, Camel Manufacturing Co. v. United States, 686 F. Supp. 912 (Ct. Int’l. Trade 1988), involving the import of camping tents. At the time, the tariff schedules had no category specifically for “tents.” The importer and Customs disagreed over the other possibilities, which were sporting goods and miscellaneous textiles. Incredibly, the decision turned on the judge’s definition of what is a “sport.” Although the case was decided under the old schedules (now replaced by the harmonized schedule), it remains one of the authors’ favorites. No case better illustrates the unpredictability of customs classifications and the importance of advance planning.

Understanding Tariff Descriptions: The Common Meaning Rule.

Articles are described in the tariff schedules in several ways: by common name (known as an eo nomine description), by a description of the article’s physical characteristics, by a description of its component parts, or by a description of the article’s use.

To understand the meaning of terms used in the tariff schedules, the courts look to the common meaning of the articles described. According to the cases, the common or popular meaning of terms used in the tariff schedules applies unless Congress clearly intended a commercial or scientific meaning to apply or unless there is a different commercial meaning that is definite, uniform, and in general use throughout the trade. Courts will often examine the legislative history of the tariff act and will consult dictionaries and encyclopedias to determine the common meaning of the terms used (e.g., is an anchovy commonly understood to be the same thing as a sardine). The courts also rely on scientific authorities and expert witnesses during the trial.

Determining the common meaning is not always so simple. In Texas Instruments v. United States, 518 F. Supp. 1341 (Ct. Int’l. Trade 1981), aff’d. 673 F.2d 1375 (C.C.P.A. 1982), the court was faced with determining the common meaning of the term “watch movement.” The plaintiff, Texas Instruments, Inc., had entered solid-state electronic watch modules and electronic watches. The articles consisted of an integrated circuit chip, a capacitor, a quartz crystal, a liquid crystal display for digital readouts, and plastic cases within which the modules were encased. Because digital watches had not yet been invented at the time the tariff schedule was enacted by Congress, the court upheld Customs’ determination that the common meaning of “watch movement” in the horological industry did not include these electronic modules. The court believed that Congress could not have intended the term “movement” to include the mere vibration of a quartz crystal in a digital watch. In addressing the impact of technological development on Customs law, the Court of International Trade stated that

Camel Manufacturing Co. v. United States

686 F. Supp. 912 (1988) Court of International Trade

BACKGROUND AND FACTS

The plaintiff imported nylon tents into the United States. The tents were designed to hold up to nine people and weighed over 30 pounds, including carrying bag, stakes, and frames. The floor sizes ranged from 8 feet by 10 feet to 10 feet by 14 feet, and when folded for carrying the tents were approximately 50 inches long. It was undisputed that the tents were used as shelter by people who wish to camp outdoors, either purely for that purpose or for the purpose of engaging in other outdoor activities such as fishing, hunting, and canoeing. The importer entered the tents as “sports equipment” carrying a 10 percent ad valorem import duty. U.S. Customs ruled that the tents were properly classifiable as “textile articles not specially provided for” and imposed a duty of 25 cents per pound plus 15 percent ad valorem. Upon liquidation, the importer appealed.

JUDGE WATSON

The basic question before the court is whether or not the activity in which the tents are used, which we shall call by the name of “camping out” is a sport, which would then lead to the conclusion that these tents are sporting equipment.

In a previous opinion, The Newman Importing Co., Inc. v. United States, 415 F. Supp. 375 (1976), this court decided that certain light tents used in backpacking were sports equipment because the activity of backpacking was found to be a sport. In this action, the court was given a generous range of opinions regarding what it is that makes an activity a sport. Seven witnesses testified on behalf of the plaintiff and two witnesses testified on behalf of the defendant. The witnesses had a wide range of familiarity with the use and manufacture of tents. Although these opinions were extremely interesting, the fact remains that in the end the question of defining the term “sporting equipment” is really one of legal interpretation for the court.

The rationale used in the Newman Importing case will not suffice here because these tents are not suitable for backpacking. The court finds that these tents are too heavy for that particular activity and, in fact, are generally used by persons who are camping in the outdoors and are not subject to strict limitations of weight in the tenting equipment which they can take with them. In the absence of persuasive proof regarding any special attributes of these tents which may contribute to their use in backpacking, the court finds it quite reasonable for the Customs Service to have excluded them from the category of backpacking tents on the basis of their weight and carrying size.

The basic question before the court is whether the general activity of camping out, i.e., taking up temporary residence in the outdoors, is a sport within the meaning of the Tariff Schedules.

The court is unable to expand its view of the term “sports” to include the activity of camping out. To do so would require a definition of the term so loose that it would cover almost any purposeful activity engaged in by humans in a natural setting. If it were simply a question of whether an activity had a certain degree of challenge and skill then the activity of gardening, which has in it a good measure of challenge, skill, and struggle and offers in innumerable ways the “joy of victory and agony of defeat,” would also have to be considered a sport. This tells us that as a matter of simple logic and meaning, it does not appear that the term “sport” can be carried past the point which was expressed in the Newman case.

It follows that these tents are not “sports equipment” within the meaning of the tariff law.

For the reasons given above, it is the opinion of the court that plaintiff’s claim for classification must be denied and judgment must issue dismissing that claim.

Decision. The importer’s classification was rejected and the decision of the government upheld. The tents were not properly classifiable as “sporting goods” because the tents were designed for camping out, which was held not to be a sport. Affirmed by the U.S. Court of Appeals for the Federal Circuit, 861 F.3d 1266 (1988).

Case Questions

1. What method does the court use to determine the meaning of an item listed in the tariff schedule? What is the meaning of the term “sports equipment?” Why are these backpacks not sports equipment?

2. Compare the classification of the tents under the old schedules used in this case, with the newer classification in the harmonized code in Exhibit 12.4. What are the differences?

3. What are the implications of this case for the importer?

The courts cannot be asked to restructure the tariff schedules by judicial fiat in order to accommodate scientific and engineering innovations which far transcend the vision and intent of the Congress at the time of the enactment of the tariff schedules. It is true… that it is an established principle of customs law that tariff schedules are written for the future as well as for present application and may embrace merchandise unknown at the time of their enactment. It must be borne in mind, however, that…in applying a tariff provision to an article, unknown at the time of the enactment thereof, such an article must possess an essential resemblance to the characteristics so described by the applicable tariff provision.

Accordingly, the court ruled that the solid-state electronic module was not a “watch movement.”

Dictionary definitions are often used to interpret the tariff schedules. In C. J. Van Houten & Zoon v. United States, 664 F. Supp. 514 (Ct. Int’l. Trade 1987), the court ruled that tariff schedule items for “bars or blocks” of chocolate weighing 10 pounds or more did not apply to imports of molten, liquid chocolate imported into the United States in tank cars. Rather, the molten chocolate was to be classified as “sweetened chocolate in any other form.” After consulting several dictionaries for the common meaning of the terms “bars and blocks,” the court concluded that this meant only solid materials.

Determining the Classification of Products: Questions of Law and Fact.

Determining an article’s tariff classification typically involves two steps. First, you must interpret the common meaning of the terms described in the tariff schedules. Second, you must look at the facts to determine if the imported articles in question fall within the particular category described in the schedules. Courts like to say that the first step in defining tariff language is a “question of law,” and the second step is a “question of fact.”

Classification by Actual or Principal Use.

The tariff schedules describe articles by name, physical characteristics, or by use. When an article is described by both its use and by name, the use provision is generally deemed to be more specific, and often controls. Principal use is that use to which articles of the kind being imported are usually put. When an article might have several uses, the principal use controls. Principal use is the use that is greater than any other single use of the article.

An article may be classified according to the actual use intended for the article. To classify according to actual use, the product must be used for the purposes listed in the schedule. The actual use must be stated to Customs at the time of entry, and the imported article must actually be used in that manner. Proof of actual use must be furnished to Customs within three years of entry.

Using the General Rules of Interpretation

The General Rules of Interpretation (GRI) are an integral part of the HTSUS and govern its use. Anyone attempting to locate a product in the schedule must first consult the six required GRI rules. A summary of the rules is given later in this section.

The six rules must be applied in numerical order. To determine how an article is classified, first consult GRI 1. This requires that an article be classified according to the four-digit heading under which it is specifically and completely described or according to any relative section or chapter notes. Most imported goods can be classified according to GRI 1.

Consider Exhibit 12.4. Heading 6306 includes “Tarpaulins, awnings and sunblinds; tents; sails for boats …” If the article is specifically and completely stated in the heading, as are “tents,” then you may proceed to look at the six-digit subheading and eight-digit tariffitem levels. Thus, “backpacking tents” would be classified under 6306.22.10.

Notice that GRI 1 also requires that you consult the official notes found at the beginning of each of the twenty-two sections and ninety-nine chapters. The notes define specific terms used in the section or chapter (such as the terms “suit” or “ensemble” when used in reference to sets of apparel). They also list specific goods that are either included or excluded from that section or chapter. For instance, Chapter 94 covers “Furniture, bedding, mattresses, mattress supports, cushions…,” but the notes to Chapter 94 state: “This chapter does not cover…pneumatic or water mattresses …dentists’ chairs… toy furniture….”

In the event that the goods cannot be classified solely on the basis of GRI 1, the remaining rules may then be consulted. They must be applied in sequence beginning with GRI 2 and proceeding in order through GRI 6. The rules deal with problems that arise when an article could conceivably be classified under more than one heading and for classifying mixtures and articles made up of component parts.

The following rules have been edited for ease of study. Consult the GRI for the official text. Study them carefully, and be sure you are able to apply them.

GRI 1. Classification shall be determined according to the terms of the headings and any relative section or chapter notes and, provided such headings or notes do not otherwise require, according to GRI 2–6.

GRI 2. (a) An article described in a four-digit heading includes the completed, finished article as well as one that is incomplete or unfinished, provided that the incomplete or unfinished article has the essential character of the complete or finished article. Articles that are entered unassembled shall be classified as the assembled article. For example, a shipment of an unassembled bicycle will be dutied as a finished bicycle, provided that all of the parts needed to make a completed bicycle arrive in one shipment.

(b) Any reference in a heading to a material or substance shall include mixtures or combinations of that material or substance. Any reference in a heading to goods made from a certain material shall include goods made wholly or partly of that material. Goods consisting of more than one material shall be classified according to GRI 3.

GRI 3. When goods are classifiable under two or more headings, the article shall be classified as follows:

(a) The heading that provides the most specific description shall be preferred to headings that provide more general descriptions. (This is known as the Rule of Relative Specificity.)

(b) Mixtures, composite goods consisting of different materials or made up of different components, and goods put up in sets for retail sale, which cannot be classified by referring to 3(a), shall be classified as if they consisted of the material or component that gives them their essential character.

(c) When goods cannot be classified by reference to 3 (a) or (b), they shall be classified under the heading that occurs last in numerical order among those that equally merit consideration.

GRI 4. Goods that cannot be classified according to the above rules shall be classified under the heading for goods to which they are most akin.

GRI 5. In addition to the foregoing, the following rules apply:

(a) Camera cases, musical instrument cases, gun cases…and similar containers, specially shaped or fitted to contain a specific article, suitable for long-term use and entered with the article for which they are intended, shall be classified with such articles when of a kind normally sold therewith.

(b) Packing materials and containers entered with the goods therein shall be classified with the goods, unless the materials or containers are clearly suitable for repetitive use.

GRI 6. The classification of goods in the subheadings shall be determined according to the terms of the subheading and any related notes, and only subheadings at the same level are comparable.

The Rule of Relative Specificity.

Recall that GRI 1 requires us to classify a product according to the four-digit heading. But suppose a product could arguably be classified under more than one heading? The rule of relative specificity, found in GRI 3(a), provides that where an article could be classified under more than one heading, it must be classified under the one that most specifically describes the item. Moreover, we must only compare the language of the headings, without reference to any of the subheadings. Only after determining that an article is classifiable under a certain heading can you then proceed to find the proper subheading. For instance, assume you are importing electric toothbrushes. There are two possible classifications. Heading 8509 includes “electromechanical domestic appliance with self-contained motor” dutied at 4.5 percent. Heading 9603 includes “brooms, brushes, including brushes constituting parts of machines,” which are duty free. Which is the correct classification? The answer is heading 8509 because it more specifically describes the items than does 9603. This is despite the fact that at the eight-digit level, 9603.10.90 includes “toothbrushes, shaving brushes, Hairbrushes….” We must first determine the most specific four-digit heading, and the description “electromechanical domestic appliance with self-contained motor” is more specific than “brooms, brushes…” In addition, where items could be classified under more than one heading, a description by name is more specific than a description of a class of merchandise. For example, tools used by a hair stylist would be classified as “shavers and hair clippers with self-contained electric motor” under heading 8510 because this description is more specific than “electromechanical tools for working in the hand with self-contained electric motor” under 8508.

Classification by Essential Character.

Suppose an article is made of two or more different materials or components. There is no heading that specifically and completely describes the entire article, but there are several headings that describe the individual materials or components. If two or more headings each describe only certain materials or components of the article, GRI 3(b) requires that the article be classified under the heading that describes those materials or components that give the article its essential character (“essential character” is not defined in the GRI). This method is helpful to determine the classification of mixtures of chemicals, foodstuffs, and other substances or materials blended together, assuming that there is no classification that fits the mixture. The rule also applies to composite goods. Composite goods are goods made up of more than one component or material. For instance, imagine a typical notebook computer that also contains a standard AM/FM radio receiver. Should it be classified as “Reception apparatus for radio telephony” under heading 8527 or as an “Automatic data processing machin[e]” under section 8471? If the notebook computer imparts the essential character to this odd contraption, it would probably be classified under 8471.

In Pillowtex Corp. v. United States, 111 F.3d 1370 (Fed. Cir. 1999), the court considered the tariff classification of comforters made from a 100 percent cotton shell and filled with white duck down. The court held that the down fill should control the classification because the essential character of the comforters was derived from the insulating ability of the filling, not from the shell. Cases involving the essential-character test are very fact intensive; they turn on a detailed analysis of the facts of the case.

Classification of Items Packaged for Retail Sale as a Set.

The essential-character test is also used when “goods are put up in sets” for retail sale. In order for a product to qualify as “goods put up in sets,” according to the definition in the Harmonized Tariff Schedule, (1) there must be no heading in the tariff schedules providing for the set as a whole; (2) there must be two or more different materials or articles classifiable under different headings; (3) they must be packaged together to meet a particular need or carry out a specific activity; and (4) they must be put up in a manner suitable for retail sale to the user without further repacking. According to this definition, a set of twelve spoons would not be a set (they are not different articles), but different types of food sold as a frozen meal would be a set.

In the following case, Better Home Plastics Corp. v. United States, 916 F. Supp. 1265 (Ct. Int’l. Trade 1996), the court had to determine whether a shower curtain set was classified under the heading for “Curtains” or under the heading for “Tableware, kitchenware, other household articles and toilet articles, of plastics…Other: Curtains and drapes including panels and valances.” Notice how the court applies the General Rules of Interpretation and the essential-character test.

Classification at the Subheading Level.

Only after an article has been classified at the heading level should the subheadings be consulted. When comparing two or more different subheadings within the same heading, the rules set out in GRI 1–5 (relative specificity, essential character, etc.) must still be followed. Articles must be compared at equal subheading levels, so that only six-digit subheadings are compared to other six-digit subheadings, and so on.

Tariff Engineering

Tariff engineering is the process of modifying or engineering your product prior to importation for the purposes of obtaining a lower rate of duty. The general rule established by the U.S. Supreme Court and followed for well over 100 years is that an article is to be classified according to its condition at the time it is imported. Thus, generally, tariff engineering is an acceptable practice. As far back as 1881, the Supreme Court stated that “if the manufacturer uses… bleaching processes in order to make his sugars more saleable, why may he not omit to do so in order to render them less dutiable; nay, why may he not employ an extra quantity of molasses for that purpose?” Merrit v. Welsh, 104 U.S. 694 (1881).

Better Home Plastics Corp. v. United States

916 F. Supp. 1265 (1996) Court of International Trade

BACKGROUND AND FACTS

Plaintiff, Better Home Plastics Corp., imported shower curtain sets. The shower curtain sets consisted of an outer textile curtain, an inner plastic magnetic liner, and plastic hooks. The plastic liner prevented water from escaping while the shower was in use. The liner was color coordinated to match the outer curtain and added to the set’s decorative appearance. The textile curtain was intended to be decorative and did not block the water from getting out on the floor. The curtain was also semitransparent, permitting the color of the plastic liner to show when the curtain and the liner were drawn. Better Home Plastics sold the sets to budget stores at prices ranging from $5.00 to $6.00, and retailers resold them at prices from $9.00 to $12.00. Customs classified the merchandise under the provision for the set’s outer curtain at a duty of 12.8 percent according to Chapter 63, Subheading 6303.92.0000 of the Harmonized Tariff Schedule (HTSUS). Better Home Plastics asserted that classification of the set was properly determined by the set’s inner plastic liner under Chapter 39, Subheading 3924.90.1010, HTSUS, at a duty of 3.36 percent ad valorem.

DICARLO, CHIEF JUDGE

The General Rules of Interpretation (GRI) govern the classification of the imported shower curtain sets under the HTSUS. GRI 1 establishes the general presumption for classification under the rules. GRI 1 provides that the headings and relative section or chapter notes determine the classification of the imported merchandise, so long as those headings or notes do not require otherwise.

GRI 3 governs where the merchandise at issue consists of more than one material or substance, such as a textile curtain and an inner plastic liner, as here. GRI 3 mandates that, when “goods are, prima facie, classifiable under two or more headings,” the court must classify the merchandise in question pursuant to the heading providing the most specific description. This is known as the rule of relative specificity. An exception to this rule exists. When, however, two or more headings each refer … to only part of the items in a set put up for retail sale, those headings are to be regarded as equally specific…even if one heading provides a more complete or precise description of the goods. Accordingly, the rule of relative specificity does not apply when two of the headings each refer only to part of the items within the set.

Goods put up in sets for retail sale, which cannot be classified according to the most specific heading, are classified by the “component which gives them their essential character” (the essential character test). Better Home Plastics contends the court must apply the essential character test, in classifying the applicable merchandise. Application of the test, Better Home Plastics asserts, would mandate classification of the set on the basis of its inner plastic liner pursuant to Subheading 3924.90.1010, HTSUS….

Defendant contends the essential character of the curtains are embodied in the textile curtain. Defendant raises numerous arguments to support its position, particularly that (1) the plastic liner is replaceable at 1/3 to 1/4 the price of the set; (2) the consumer purchases the set because of the decorative function of the outer curtain, and not for the protection afford by the liner; and (3) the liner is only employed for the limited period that someone is utilizing the shower, whereas the decorative outer curtain is employed, at a minimum, when the bathroom is in use, and as much as 24 hours a day. Defendant also contends Better Home Plastics’ invoice description supports Customs’ classification. Pursuant to the invoice description, the set is sold as “Fabric Shower Curtain and Liner.” Therefore, defendant argues, this description serves as an admission that the curtain provides the essential character of the set.

Although the court agrees that the curtain in the imported set imparts a desirable decorative characteristic, nonetheless, it is the plastic liner that provides the indispensable property of preventing water from escaping the shower enclosure. The liner (1) prevents water from escaping when the shower is in use; (2) protects the fabric curtain from mildew and soap scum; and (3) conceals the shower and provides privacy when the shower is in use. Further, the plastic liner can serve its intended function without the outer curtain and contributes to the overall appearance of the set. The outer curtain, in contrast, merely furthers the set’s decorative aspect. The court therefore concludes the essential character of the set is derived from the plastic liner.

Defendant’s other contentions are also unpersuasive. The manner in which the set is invoiced does not definitively determine which component provides the essential character of the set. The invoice description is intended to characterize the shipped item; it is not a declaration of the relative importance of its component parts. Finally, while the court takes into consideration the relative cost of the component parts, this point alone is not dispositive, nor very persuasive against the competing arguments.

It is the essential character of the set—derived in part from the plastic’s ability to repel water—that denotes the set’s utility, purpose, and accordingly, character. Inclusion of the textile curtain within the classification for the plastic liner does little to change the qualities or the basic nature of the set in meeting this purpose.

The court finds Better Home Plastics has overcome the presumption of correctness accorded to Customs, and the shower curtain sets were improperly classified under subheading 6303.92.0000, HTSUS. In addition, the court agrees with Better Home Plastics’ proposed classification of the sets under subheading 3924.90.1010, HTSUS.

This decision is limited to its facts, i.e., that the set at issue is at the low end of the shower curtain market. The court does not offer an opinion on the proper classification of sets targeted to a different market segment.

Decision. When articles are made up of component parts, or are in sets, and their parts are referred to in two equally specific headings, then the rule of relative specificity does not apply, and their classification must be determined by which part gives the article its essential character. In this case, the shower liner imparted the essential character to the set.

Comment. Judge DiCarlo’s opinion was affirmed by the U.S. Court of Appeals in Better Home Plastics Corp. v. United States, 119 F.3d 969 (Fed. Cir. 1997).

Case Questions

1. What are the two main components of this “set”? If they had been sold separately, how would each have been classified?

2. What is the proper rule for determining the classification of a set?

3. What is the “rule of relative specificity,” and why was it not used here?

4. Why would Better Home spend the time and money to contest Customs’ classification?

Tariff engineering permits importers to design their products or to enter their goods at any step in the manufacturing or assembly process, in order to obtain a lower rate of duty.

Of course, there are some limits on tariff engineering. There must be no fraud or deception, the goods must be correctly described on the entry documents, and they must be honestly presented to Customs for inspection if requested. In Heartland By-Products, Inc. v. United States, 264 F.3d 1126 (Fed. Cir. 2001), the importer added molasses to sugar syrup in Canada and removed it after the syrup was imported into the United States. The syrup with molasses entered free from U.S. tariff-rate quotas on sugar syrup imports. Customs maintained that there was no other purpose for adding molasses except to avoid the quota, that the molasses was a “foreign substance,” and that adding it was not a genuine step in the manufacturing process. Since the molasses was later returned to Canada to be reused for the same purpose, Customs maintained that the process was done for “disguise or artifice” to circumvent the customs laws. There was no evidence that Heartland ever falsified or concealed the identity of its sugar syrup, its method of manufacture, or its use. The Court of Appeals agreed with Customs’ argument and upheld its reclassification of the syrup.

Customs Valuation

The customs value, often called dutiable value, of all goods entered into the United States must be established and reported to U.S. Customs at the time of entry. All relevant facts and terms of the contract of sale that affect value must be disclosed. Dutiable value is defined by U.S. law as the transaction value of the goods. The transaction value of the merchandise is the price actually paid or payable for the merchandise when sold for exportation to the United States, plus the following amounts if not included in the purchase price: (1) packing costs (including containers, covers, and labor for packing) incurred by the buyer, (2) any selling commission incurred by the buyer, (3) the value of any “assist,” (4) any royalty or license fee that the buyer is required to pay as a condition of sale, and (5) the proceeds of any subsequent resale of the merchandise that accrues to the seller. Transaction value does not include international freight charges, insurance or customs brokerage fees, inland freight after importation, charges for assembling or maintaining the goods after importation, or import duties. Charges for transporting the goods in the country of exportation (e.g., from the seller’s factory to the port) are also excluded when these charges are identified separately on the seller’s invoice. Transaction value is not affected by whether the sales contract called for CIF or FOB payment terms. If the price is expressed as CIF, the freight and insurance will be deducted; if FOB, the freight and insurance were not included anyway.

Importers are often required to pay royalties or license fees to the holders of copyrights, trademarks, or patents for the privilege of importing merchandise subject to those rights. Design and engineering fees may have to be paid to foreign firms separately from payments to the actual producer of the product. Sometimes these payments are made through the seller or exporter of the merchandise. When such payments are made “as a condition of sale of the imported merchandise for exportation to the United States,” they are included in transaction value. For instance, if a firm imports blue jeans manufactured in Hong Kong and as a condition of sale makes royalty payments to the designer of the jeans in Paris, the royalty would be included in the transaction value of the merchandise.

Agency Commissions.

The importance of transacting business through a foreign agent is stressed many times in this text. Agents are used both by sellers attempting to export to foreign markets and by buyers attempting to source materials or goods from foreign suppliers. The terms of the relationship between the importer and the agent can have a distinct impact on the calculation of transaction value. Although commissions paid to a buying agent (an agent of the buyer/importer) are generally not included in transaction value, payments made to or for the benefit of the seller or seller’s agent are included. Customs carefully scrutinizes the relationship between U.S. importers and their buying agents to be sure that dutiable value is accurately reported.

In Monarch Luggage Co. v. United States, 715 F. Supp. 1115 (Ct. Int’l. Trade 1989), the importer successfully structured a business transaction so that the buying commissions were excluded from transaction value. Although representatives of Monarch traveled to the Far East several times a year to meet with their suppliers, inspect their facilities, and place orders for luggage, they nevertheless maintained a local agent there. Under a written agreement, the agent was to locate the best sources for luggage and visit the suppliers to determine the quality of the luggage, but could place orders only at Monarch’s direction. The agent coordinated payment for the luggage and arranged transportation according to Monarch’s explicit instructions. The supplier and not the agent absorbed the loss of defective merchandise. The agent bore no risk of loss to the goods and never took title to them. The agreement further stated that “the agent shall never act as a seller in any transaction involving the principal.” Most importantly, Monarch made the payments to its agent directly and separately and not as a part of the invoice price paid to the supplier of the luggage. In other words, the agent was in fact a representative of the buyer and not an agent of the seller. The fees paid to the agent were not included in dutiable value.

Production Assists.

Importers will occasionally provide some form of production assistance to a foreign manufacturer or producer from whom they are purchasing goods. Production assists, also called dutiable assists, are goods, services, or intangibles furnished by the importer to a foreign producer, free or at a reduced price, for use in producing merchandise for import and sale in the United States. Examples of assists include (1) materials and component parts incorporated in or used in the production of the imported merchandise; (2) machinery, tools, dies, or molds; and (3) engineering, development, artwork, and design, or plans and sketches performed outside the United States and that are necessary for production. The value of an assist made to a foreign firm must be included in transaction value when the goods are imported into the United States. Production assists might be provided when a foreign firm needs special equipment or machinery to manufacture custom or specially designed goods. It might reduce costs by putting to use underutilized equipment belonging to the importer, while taking advantage of the foreign producer’s low-cost labor or economies of scale. Assists might also allow the importer some greater control over the quality of the finished product. Assists are often used as part of a plan for contract manufacturing—a business arrangement in which the production of goods is contracted or “outsourced” by one firm to a manufacturing firm, often overseas. They also result from multinational companies with operations in many countries. A multinational may have research and development facilities in one country, derive parts from other countries, and conduct final assembly in yet another country. These companies should maintain accurate accounting and documentation of all assists.

In Texas Apparel Co. v. United States, 698 F. Supp. 932 (Ct. Int’l. Trade 1988), the importer provided sewing machines to a Mexican manufacturer and paid the cost of repairs to the machines. The machines were used to produce garments sold to the importer in the United States. The court held that if the machines were supplied to the Mexican firm free of charge or at a reduced cost, then the value of the machines had to be included in the dutiable value of the garments as an assist. In Salant v. United States, 86 F. Supp. 2d 1301 (Ct. Int’l. Trade 2000), the importer provided free rolls of fabric to a foreign shirt manufacturer for use in making shirts for sale back to the importer. The court upheld customs regulations under which the value of the assist included the value of the fabric that went into the shirts as well as the value of the scrap fabric discarded as waste because including all of the fabric was more in keeping with “generally accepted accounting principles.”

Other Methods of Calculating Dutiable Value.

When the transaction value of imported merchandise cannot be determined, Customs will use the value of identical or similar merchandise. The identical or similar merchandise used in the comparison must have been recently sold for export to the United States at the same level of trade (manufacturer to distributor, distributor to retailer, for example) and in quantities similar to the entry being valued.

If dutiable value cannot be determined by any of these methods, Customs will utilize the deductive value or computed value methods. Deductive value is the resale price of the goods (including packaging costs) in the United States after importation, less international and inland freight, insurance, customs duties, brokerage fees, commissions, and expenses of refining, assembling, or further manufacturing incurred in the United States. The final method for calculating the value of imports gives the computed value. Computed value is calculated by adding the costs of raw materials, processing or fabricating, overhead, labor costs, packing costs, the value of any assist, and an amount for profit.

Currency Exchange Rates.

If imported products are invoiced in a foreign currency, customs valuation is not based on the actual amount paid to the foreign supplier in U.S. dollars according to the exchange rate obtained by the importer. Rather, the goods will be valued in dollars based on the exchange rate certified by the Federal Reserve Bank of New York on the day of export from the foreign country.

Rules of Origin

Imagine that it is 1989 and that your trading company has firm commitments from buyers in the United States to take all of the ostrich chicks that you can provide during the next year. After considerable searching and time spent traveling the world, you find an ostrich hatchery in England. You enter into a sales contract with the hatchery, with payment to be made under a confirmed letter of credit. Your bank pays the seller cash on the documents, and the chicks arrive peeping and squawking at a U.S. port of entry. The chicks are entered with their country of origin listed as Great Britain. An astute customs inspector realizes that the chicks could not possibly have “originated” in that country and corrects the country of origin to South Africa where the eggs obviously originated. You agree that the fertilized eggs originated in South Africa but argue that their incubation and hatching in Great Britain amounts to a “substantial transformation” and that Great Britain therefore became the country of origin. U.S. Customs ruled that the processing of the eggs in Great Britain was a natural biological consequence of the initial fertilization of the eggs in South Africa, that the chicks continued to be a product of South Africa, and that they are prohibited from entering the United States under a U.S. law banning the import of products from South Africa. (The ban was lifted in the early 1990s following the end of apartheid and political changes in South Africa.) This not-so-hypothetical case illustrates how critical it is to know the proper rules of origin needed to determine the country of origin of imported goods.

Definition and Purposes of Rules of Origin.

Rules of origin are the national laws and regulations of administrative agencies, usually customs authorities, which are used to determine the country of origin of imported products. No importing country will permit goods to be imported unless the country of origin of the goods is properly determined and reported to customs authorities.

In the United States, rules of origin are administered and enforced by U.S. Customs and Border Protection. The country of origin is used to determine the following:

• The normal tariff rate on an import

• Whether an import is subject to a preferential tariff rate or an increased rate

• Whether an import is subject to antidumping or countervailing duties

• Whether an import is subject to a quota, embargo, or other trade restriction

• The applicability of government procurement rules

• The proper country of origin labeling to be affixed to the product

• Statistical information

At first thought, one would think that determining the country of origin would be pretty simple. If a product is made in one country, entirely through processes and from raw materials and components originating there, the country of origin is not difficult to determine. Bananas grown in Honduras and shipped directly to supermarkets in the United States are products of Honduras. Plywood sheets glued and pressed in Brazil, from trees grown in Brazil, are obviously products of Brazil. Men’s shirts that were cut and sewn in China, from fabric dyed and woven there, from yarn spun there, that was made completely from cotton grown there, are products of China. But as with our ostrich chicks, it is not always so easy. The country of origin is not merely the country from which the goods were purchased or from where they were shipped. If that were the case, one could enter Italian leather products into the United States at the lower Mexican tariff rate by simply routing them through Mexico. In today’s global economy, raw materials and component parts circle the earth, finding their way into assembly lines and manufacturing plants stretched around the world. Thus for most manufactured, processed, or assembled articles, the country of origin can only be determined by resorting to the rules of origin in effect in the importing country. The rules of origin vary from country to country, and from product to product. They can be complex, arcane, and often require firms to seek professional advice or to obtain an advance ruling from customs authorities.

Types of Rules of Origin.

There are two general types of rules of origin, non-preferential and preferential. Non-preferential rules of origin are those that determine the country of origin of goods imported from countries that have been granted normal trade relations status (NTR, formerly “most favored nation”) by the importing country. This applies to most trade between developed countries that are not part of a free trade area or customs union. For instance, trade between the United States and Europe, or China, is on NTR terms. Preferential rules of origin are those that determine the country of origin on goods imported from countries that have been granted a trade preference by the importing country. A trade preference is some advantage or favorable treatment (usually a reduced tariff or duty free treatment) granted by one country to the imports of another country. Preferences usually result from a bilateral or regional free trade agreement, or from a trade preference program for developing countries. The North American Free Trade Agreement, among Canada, Mexico, and the United States, is an example of a regional trade agreement with its own rules of origin. Every free trade agreement and preference program has its own rules that determine when goods will qualify for free trade or preference status. (See Exhibit 12.4 for a list of U.S. tariff preferences in effect at the time of this writing.) Some countries, such as the United States, also have separate rules for imports of textile and apparel, government procurement, and automobiles. To complicate matters, the rules of origin differ according to the purpose for which they are being used. Rules used to determine the rate of duty on imported goods, for example, may be different from the rules of origin used to determine country of origin labeling of those goods. As such, we caution that no reader should rely on the general principles discussed in the following sections, but should seek professional advice, obtain a customs ruling, or be prepared to carefully research the rules of origin applicable to their specific transaction. The various rules of origin can be found in the harmonized tariff schedules of most countries (in the United States, the HTSUS) and by reference to free trade agreements and to the rules and decisions of customs authorities and courts. In the United States, there are many court decisions interpreting the rules of origin.

The General Rule in the United States.

If an article is wholly the growth, product, or manufacture of one country, then the country of origin is that country. In other words, the country of origin is that single country where an article is wholly and completely produced or manufactured entirely from raw materials originating in that country. Of course, few products today are wholly made in one country entirely from materials derived there. More and more products are subjected to manufacturing, processing, and assembly operations on a global scale. Agricultural commodities grown in one country may be processed into food in another. Steel produced in one country may shipped to another country to be galvanized, or transformed or processed into wire, steel plates, girders, or automobile parts. An automobile destined for the United States may be assembled in Latin America or Canada from parts and materials that originated in or were assembled in dozens of countries. Some products can involve hundreds or thousands of component parts that have been manufactured and assembled in plants located on several continents. But there can be only one country of origin for customs purposes, even for products that undergo manufacturing operations in several different countries. Importers are therefore expected to accurately track the movement of materials and understand the complex manufacturing or assembly processes, which in turn allows them to accurately determine an article’s country of origin. This can be especially difficult where manufacturing is subcontracted to foreign companies in distant regions of the world, and the customs entry is done by a distributor or retailer, such as Walmart, who may not be completely familiar with the manufacturing process.

The Substantial Transformation Test

If an article is not wholly the growth, product, or manufacture of one country, then the country of origin is that country where the article last underwent a substantial transformation. The meaning of the term can only be understood by looking at its history.

For a century, the courts of the United States have held that a substantial transformation occurs when the original article or product loses its identity as such and is transformed into a new and different article of commerce having “a new name, character, or use” different from that of the original item. In 1908, the U.S. Supreme Court ruled that imported cork had not been substantially transformed when it was dried, treated, and cut into smaller sections for use in bottling beer. The Court stated, “Something more is necessary…. There must be a transformation; a new and different article must emerge, having a distinctive name, character or use. This cannot be said of the corks in question. A cork put through the claimant’s process is still a cork.” Anheuser-Busch Brewing Association v. United States, 207 U.S. 556 (1908). Since then, many courts have tried to interpret this phrase and to apply it to many different products and manufacturing operations.

The name, character, or use test is used to determine the country of origin for tariff purposes (other than in specialized cases, such as those falling under the North American Free Trade Agreement), as well as to determine how foreign-made products are to be marked or labeled. U.S. law strictly requires that every foreign-made article imported into the United States be marked or labeled in English so as to indicate the country of origin of the article to the ultimate purchaser.

Suppose an article is taken from Country A to Country B, where it is subjected to a refining process that combines it with other materials. If the process in Country B amounts to a substantial transformation so that a new product emerges with a new “name, character, or use,” then the article may be entered into the United States at the rate of duty applicable to Country B’s products, and marked as “Made in Country B.” For example, if stainless steel bars are made in Korea and shipped to Germany (or any other NTR country) where they are turned into fine cutlery, it can enter the United States under the tariff rate for German cutlery and be labeled “Made in Germany” if the processing in Germany amounted to a substantial transformation that created a new and different article of commerce with a new “name, character, or use.” Similarly, if foreign raw materials are imported into the United States and put through a manufacturing process that substantially transforms them into a product with a new “name, character, or use,” the new product need not be marked as of foreign origin when sold to the ultimate purchaser. In other words, the foreign raw materials were transformed into a product of the United States.

The landmark case Gibson-Thomsen Co. v. United States, 27 C.C.P.A. 267 (1940)[BB] involved the application of the “name, character, or use” test under the marking and labeling laws of the United States. The court ruled that when wooden handles and blocks were imported into the United States from Japan, then drilled with holes into which American bristles were inserted, and with the final product being sold in the United States as toothbrushes and hairbrushes, the imported wooden components had “lost their identity in a tariff sense” and had been transformed into products of the United States. The court took account of the fact that the bristles, which had been of U.S. origin, were a key component of the new product. Because the transformation took place in the United States, the wooden handles did not have to be marked as having originated in Japan. Gibson-Thomsen is often cited by courts today.

Since 1940, the courts have interpreted and refined the “name, character, or use” concept. Some courts have looked to see if a “new article of commerce” emerges from the transformation. For instance, in a 1970 case, a court ruled that unfinished furniture chair parts were substantially transformed by the importer into chairs that were new and different articles of commerce. Similarly, wooden sticks imported into the United States and then set into liquid ice cream and frozen have been held to be substantially transformed into a new product having a new name, character, and use. In a 1960 case, a court ruled that the winding of typewriter ribbon onto imported spools resulted in a substantial transformation of the spools because the imported spool became an integral part of the whole product with which it was combined. In 1984, Customs used the same rationale for deciding not to impose country of origin marking requirements on the plastic spools and shells in which audio cassette tape is wound. Although many cases look to see if the name commonly given the transformed article has changed, a product’s name is generally considered to be only one of several factors to take into account. Greater emphasis is usually placed on whether the essential character—sometimes said to be the “essential nature”—of the product or its use has changed.

Many of the modern cases also look to see whether the substantial transformation has resulted in an increase in value, called the value-added test. In National Juice Products Association v. United States, 628 F. Supp. 978 (Ct. Int’l. Trade 1986), a U.S. company had imported evaporated orange concentrate and blended it with water, orange oils, and fresh juice to make frozen orange concentrate. The blending and processing in the United States had added only a 7 percent value to the orange juice. The court held that the orange juice sold to consumers had to be labeled with the foreign country of origin.

In Uniroyal, Inc. v. United States, 542 F. Supp. 1026 (Ct. Int’l. Trade 1982), aff’d. per curiam, 702 F.2d 1022 (Fed. Cir. 1983), the court ruled that a substantial transformation had not occurred when the leather upper portion of a shoe was imported and then attached to the preformed rubber sole in the United States and sold as a “Sperry Topsider.” The court relied heavily on evidence that the time and cost of producing the leather upper in Indonesia were much greater than the time and cost of attaching it to the rubber sole (called a “minor assembly operation”). The court also considered that the fashioning of the leather uppers in Indonesia required far greater skill than was required to attach the sole in the United States. The court stated that “[I]t would be misleading to allow the public to believe that a shoe is made in the United States when the entire upper—which is the very essence of the completed shoe—is made in Indonesia and the only step in the manufacturing process performed in the United States is the attachment of an outsole.” The court noted that unlike the earlier case involving typewriter spools, the upper leather portion of the shoe was not just a vehicle for selling something else, but was the major reason that consumers selected this shoe.

Customs has frequently addressed whether the assembly in one country of component parts made in another country or countries is a substantial transformation. Customs looks at the totality of the circumstances. Typically, it rules that a simple assembly is not a transformation, whereas a “meaningful” assembly is. Customs looks at the nature and number of operations, the time involved, the level of skill, detail and quality control necessary for the assembly, and, to a lesser extent, the number of components. If the assembly leaves the identity of the original item intact, as was the case with the boat shoes, there is no substantial transformation. They will determine if the complete product has a new name, character, and use. In a 2008 determination, Customs considered the assembly in Mexico of ground fault interrupters (like those used in bathroom and kitchens to prevent shock) made from 30 Chinese components, taking 43 steps in 10 minutes. Customs noted that the Chinese printed circuit board was the major functional part, that the circuit board provided the “essential character” to the final product, that all of the components had originated in China, most of the assembly time was devoted to testing, and that the assembly operation was not complex. They entered the U.S. as products of China, not Mexico. Notice of Issuance of Final Determination Concerning Ground Fault Circuit Interrupter, 73 Fed. Reg. 54,420 (Sept. 19, 2008).

Ferrostaal Metals Corp. v. United States illustrates the difficulty of determining whether a substantial transformation has occurred. As this case shows, the precise definition of substantial transformation is unclear because so many factors can be considered. The courts have recognized that it is difficult to take legal concepts applicable to products such as textiles and apply them to combinations of liquids or the fabrication of steel articles. Faced with complex cases, courts have developed rules on a case-by-case basis. The unpredictable nature of these court rulings increases importers’ difficulties in interpreting and applying the rules of origin, as evidenced by the large number of customs cases appealed to the courts.

As you read, consider the actual process of hot-dip galvanizing described here. Would you agree that the operations performed on the steel in New Zealand created a product with a new “name, character, or use”?

North American Preferential Rules.

The North American Free Trade Agreement (NAFTA) eliminates all normal tariffs on goods traded among Canada, Mexico, and the United States, provided that the goods originate in one of those countries. Under the NAFTA rules of origin, goods originate in North America if they are wholly obtained or produced there (or as some writers have said with a little exaggeration and humor, “wholly” means that the goods cannot have “one atom” that did not originate in North America). Goods that are made from materials or components that originated outside North America qualify for free trade status only if each and every non–North American material or component (called inputs) has undergone the change in tariff classification required in NAFTA Annex 401. For example, a product manufactured in Canada from several different raw material inputs originating in Europe can be shipped to the United States as having originated in North America (at the tariff rate applicable to Canadian goods and labeled “Made in Canada”) only if every single one of the European materials or components underwent the change in tariff classification set out in the NAFTA agreement when they were made into the final product in Canada. This is known as the NAFTA tariff shift rule. Automobiles, trucks, and certain other goods are subject to both the tariff-shift and “regional value-content” rules. NAFTA rules can be found in the general notes to the harmonized tariff schedules. See the NAFTA chapter for additional information.

Ferrostaal Metals Corp. v. United States

664 F. Supp. 535 (1987) Court of International Trade

BACKGROUND AND FACTS

Plaintiff attempted to enter steel products at the Port of Seattle. They consisted of unpainted steel sheets that had originated in Japan but had been hot-dip galvanized in New Zealand. Plaintiff’s entry documents identified New Zealand as the country of origin. Customs ruled that the country of origin was Japan and that the steel was therefore subject to a voluntary restraint agreement between the United States and Japan. Customs contended that hot-dip galvanizing of Japanese steel sheets in New Zealand was merely a “finishing process” carried out to improve certain performance characteristics of the steel sheets and not a process that results in a substantial transformation so as to change the country of origin. The plaintiff disagreed and brought this action for review.

JUDGE DICARLO

Substantial transformation is a concept of major importance in administering the customs and trade laws. In addition to its role in identifying the country of origin of imported merchandise for purposes of determining dutiable status, or, as in this case, the applicability of a bilateral trade agreement, substantial transformation is the focus of many cases involving country of origin markings….

The essence of these cases is that a product cannot be said to originate in the country of exportation if it is not manufactured there. The question, therefore, is whether operations performed on products in the country of exportation are of such a substantial nature to justify the conclusion that the resulting product is a manufacture of that country. “Manufacture implies a change, but every change is not manufacture….

There must be transformation; a new and different article must emerge, ‘having a distinctive name, character, or use.’” Anheuser-Busch Brewing Ass’n. v. United States, 207 U.S. 556, 562, 28 S.Ct. 204, 206 (1908). The criteria of name, character, and use continue to determine when substantial transformation has occurred, and the prior cases of this court and our predecessor and appellate courts provide guidance in the application of this test.

* * *

Whether galvanizing and annealing change the character of the merchandise depends on the nature of these operations and their effect on the properties of the materials To produce one of the types of imported sheet… the sheet must be heated to 1,350 degrees F, at which point recrystallization of the grains of steel occurs. The sheet is then brought down to 880 degrees F, before galvanizing begins. At 880 degrees F, the sheet enters a pot of molten zinc and is dipped. The molten zinc reacts immediately with the solid steel, and begins a process known as “alloying.” Alloying constitutes a chemical change in the product, characterized by the formation of iron-zinc alloys at the interface between the steel and the zinc. The galvanized steel sheet emerging from the bath has a mixed zinc-steel surface with an identifiable atomic pattern. The formation of a galvanized surface is an irreversible process which provides electrochemical protection to the sheet. As a result of the galvanic protection, the steel will last up to twenty years, or ten times as long as ungalvanized steel….

The alloy-bonded zinc coating affects the character of the sheet by changing its chemical composition and by providing corrosion resistance. The court also finds that the hot-dip galvanizing process is substantial in terms of the value it adds to full hard cold-rolled steel sheet. The evidence showed that the Japanese product is sold for approximately $350 per ton, while the hot-dipped galvanized product is sold for an average price of $550 to $630.

Taken as a whole, the continuous hot-dip galvanizing process transforms a strong, brittle product which cannot be formed into a durable, corrosion-resistant product which is less hard, but formable for a range of commercial applications. Defendant’s witness stated that the imported sheet has a “different character from the standpoint of durability.” The court finds that the annealing and galvanizing processes result in a change in character by significantly altering the mechanical properties and chemical composition of the steel sheet.

The court also finds substantial changes in the use of the steel sheet as a result of the continuous hot-dip galvanizing process. Testimony at trial overwhelmingly demonstrated that cold-rolled steel is not interchangeable with steel of the type imported, nor are there any significant uses of cold-rolled sheet in place of annealed sheet.

The name criterion is generally considered the least compelling of the factors which will support a finding of substantial transformation. Nonetheless, the satisfaction of the name criterion in this case lends support to plaintiffs’ claim. The witnesses for both parties testified that the processing of full hard cold-rolled steel sheet results in a product which has a different name, continuous hot-dip galvanized steel sheet.

The court also considers relevant whether the operations underlying the asserted transformation have effected a change in the classification of the merchandise under the Tariff Schedules of the United States. Change in tariff classification may be considered as a factor in the substantial transformation analysis. Here this factor supports a substantial transformation. Full hard cold-rolled steel sheet is classified under item 607.83, TSUS, while continuous hot-dip galvanized steel sheet is classifiable under item 608.13, TSUS. (The TSUS was the forerunner to the Harmonized Tariff Schedule.)

Based on the totality of the evidence, showing that the continuous hot-dip galvanizing process effects changes in the name, character, and use of the processed steel sheet, the court holds that the changes constitute a substantial transformation and that hot-dipped galvanized steel sheet is a new and different article of commerce from full hard cold-rolled steel sheet.

Decision. Japanese steel that had been galvanized in New Zealand prior to its importation into the United States was substantially transformed so that it had become a product of New Zealand and thus was not subject to voluntary restraint agreements between the United States and Japan.

Comment. “Voluntary restraint agreements” such as those described in this case to restrict steel imports from Japan are no longer used as a method of limiting imports of foreign goods into America, as they do not fall under the permissible rules of the WTO. Nevertheless, this case serves well to illustrate the use of the substantial transformation test in tariff cases. The case was cited in 2003 by U.S. Customs in a ruling determining the country of origin of fiber optic cable.

Case Questions

1. Why is the process of galvanizing steel important to the court’s decision?

2. Describe the results of the processing that took place in New Zealand.

3. Of the three factors generally referred to—name, character, use—which seem to be the most or least important?

4. What other factors does the court consider in addition to a change in the name, character, and use of the product?

5. Why is the court’s reference to change in tariff classification interesting today?

Other Trade Preference Rules.

The United States grants trade preferences to countries other than NAFTA. Preferences are found in bilateral and multilateral free trade agreements, such as those with Israel, Jordan, Chile, or the Caribbean countries, or in programs such as the

Africa Growth and Opportunity Act

that gives preferential duty treatment to imports of goods from Africa. Each trade agreement or program has its own rules of origin, including a version of the substantial transformation test. We will cover these later in this chapter.

Coming Changes in Rules of Origin?

In 2008, U.S. Customs announced that it was considering abandoning the judicially made substantial transformation test, like those in the cases we discussed, and moving to the tariff shift rule for all imports. Customs favors this rule because it is more precise and not as subjective as the substantial transformation test. Such a rule would be less subject to misinterpretation, argument, and court action. However, as of this writing, Customs has not implemented the rule.

WTO Agreement on Rules of Origin

Exporters and importers worldwide would benefit greatly from standardized rules of origin, which would let them more accurately determine the country of origin of their shipments in advance. This would help in product labeling as well as in determining the rate of duty and other laws applicable to their products. The WTO Agreement on Rules of Origin (1995) is a long-term project to achieve this goal. As of this writing, the WTO was in the process of developing new, uniform rules. These rules will apply to all trade between countries that are members of the WTO. Under the proposed rules, the country of origin would be determined by a tariff shift rule, similar to that used in the NAFTA agreement.

Special Rules of Origin for Textiles and Apparel

The world’s textile and apparel industry operates on a global scale. Textile firms shift the site of spinning, weaving, cutting, sewing, and other operations from country to country and from region to region to take advantage of low-cost labor and materials and to benefit from customs and tariff laws in the country in which the goods will be sold. For instance, cotton might be grown and spun into yarn in China, where it is woven into cloth. The cloth might be sent to Hong Kong, where it is cut to form pieces of garments (e.g., sleeves, collars, etc.), and then sent to Honduras for assembly. Textile and apparel manufacturers must consider the rules of origin in sourcing yarn, fabric, and other raw materials or in locating textile dyeing and finishing operations, cut-and-sew plants, or assembly operations.

Textile and apparel imports in the United States are governed by specialized rules of origin. (Textiles sold in North American follow NAFTA rules of origin.) Textile rules are more complex and arcane than rules applicable to other products, which makes it more difficult for firms to import textiles than almost any other product. Many factors determine the country of origin of textile and apparel products: the type of product (e.g., yarn, fabric, clothing and apparel, or textile products for the home), the fiber content (e.g., silk, wool, or cotton), and the steps or processes that take place in the transition from yarn to fabric to final product. The administrative rules of origin for textile and apparel products promulgated by U.S. Customs can be found in 19 CFR 102.21.

Here are a few generalizations: Many textile products are covered by tariff shift rules, under which the country of origin is determined by whether or not the operation (weaving, cutting, assembly, or whatever) causes a specified shift in the tariff classification of a raw material. The country of origin of certain items, including many home textile products, is often the country where the fabric was formed by weaving or some other fabric-making process, regardless of where it was cut and assembled into a finished product. Products that are knitted to shape, such as hosiery, socks, knitted gloves, and mittens, generally originate in the country in which they were knitted. Some articles, such as clothing and apparel, originate in the country where they were wholly assembled, or if none, where the most important assembly or manufacturing process took place. Other items are said to have originated where the fabric from which they were made was dyed and printed (when combined with two or more finishing operations), rather than where they were woven. Cutting fabric into pieces, without more, is not enough to confer country of origin status. Clearly, anyone determining the country of origin of a textile product must understand textile production processes and be able to accurately trace all steps of global operations from beginning to end. Critics of the rules of origin point out that there is no logical method to the rules and many commentators believe they derive primarily from political considerations.

These contradictory and confusing rules often stymie the most experienced importers. So, textile and apparel manufacturers and importers rely heavily on attorneys and customs brokers that specialize in textile imports. They also frequently obtain binding ruling letters from U.S. Customs in advance of setting up operations to be certain that they comply with the law.

Opportunities for Business Planning.

The rules of origin can provide a resourceful importer with significant opportunities for good business planning. With proper legal advice, a firm can structure its global operations to minimize tariffs and take advantage of the favorable trade and tariff treatment granted to goods coming from particular foreign countries. After all, trade and tariff laws are designed in part to either encourage or discourage trade with particular nations. Many firms, particularly multinational corporations, are therefore capable of shifting global resources and production facilities to those countries whose goods receive the most favorable trade and tariff treatment in the United States or other major importing nations. But to do this, the corporation must follow the importing nation’s rules of origin meticulously. The tariff savings can be so great that some unscrupulous U.S. importers have been tempted to transship articles through developing countries, repackage or relabel them, and then enter them into the United States at the lower tariff rate. The penalties for furnishing false information to U.S. Customs authorities are quite severe.

Marking and Labeling of Imports

The United States has two key laws that require imports to be labeled with the country of origin: the marking rules of U.S. Customs and the Federal Trade Commission (FTC) rules. The rules of U.S. Customs apply to country of origin markings of all imported products sold in the United States. The FTC rules apply primarily to the use of “Made in U.S.A.” or similar terms. To be labeled “Made in U.S.A.,” a label must meet the requirements of both agencies.

Customs Marking Rules.

Every article of foreign origin imported into the United States must be indelibly and permanently marked in English in a conspicuous place and in such a manner as to indicate the name of the country of origin of the article to the ultimate purchaser in the United States. The ultimate purchaser is the last person in the United States who receives an article in the form in which it was imported. If an imported article is to be sold at retail in the same form as it was imported, then the retail customer is the “ultimate purchaser.”

If the imported article is converted, processed, or combined with other articles or ingredients in the United States so that it undergoes a substantial transformation resulting in a new article of commerce with a new name, character, or use, as defined by the Gibson-Thomsen case, then the U.S. firm that transformed the article is considered the ultimate purchaser. As a result, the new product need not be labeled with a foreign country of origin.

Does that mean that it can be labeled “Made in U.S.A.”? Perhaps not. As we will see in the next section, the FTC rules take precedence, and they will not allow that claim unless the new product is “all or virtually all” made in America. Because the product was only “transformed” in the United States from foreign materials, it might be labeled “Made in U.S.A. of Imported Materials.”

Items Not Requiring Marks.

Customs regulations specify many articles by name that are exempt from marking requirements. These are generally objects that are incapable of being marked because of their size or special characteristics. Examples include works of art, unstrung beads, rags, nuts, bolts, screws, cigarettes, eggs, feathers, flowers, cellophane sheets, livestock, bamboo poles, maple sugar, vegetables, and newsprint. In addition, the following general exemptions exist for certain categories of products: (1) products incapable of being marked; (2) products that cannot be marked without injury; (3) crude substances; (4) articles produced more than twenty years prior to importation; (5) products of possessions of the United States; (6) articles imported solely for the use of the importer and not intended for resale (e.g., personal articles purchased abroad by a tourist); (7) products of American fisheries that are entered duty-free; and (8) certain products of the United States that are exported and returned. In addition, articles used by an importer as samples in soliciting orders and that are not for sale are exempted from the marking requirements.

When an item is exempt from marking requirements, the container in which it is sold to the consumer must be marked. To illustrate, imported carpentry nails need not be marked, but the box in which they are sold to the consumer must be.

Federal Trade Commission “Made in U.S.A.” Rules

In the United States, the FTC and U.S. Customs have overlapping jurisdiction with regard to country of origin claims. While Customs oversees foreign country of origin marking (“Made in China”), the FTC regulates the use of the term “Made in U.S.A.” Customs rules apply only to product marking, whereas the FTC rules apply to all claims, including those on product labels, catalogs, packaging, and all forms of advertising. Customs rules are more complex and detailed, whereas the “Made in U.S.A.” rules of the FTC are more flexible and are based on whether or not the claims would mislead or cause deception in the minds of the average consumer. The FTC bases its rules on its authority under the Federal Trade Commission Act to prevent unfair or deceptive trade practices.

There is no rule that requires a U.S.-made product to be labeled as such. Except for special rules applicable to automobiles and textile and fur products, U.S. content need not be disclosed. However, a seller may not claim that a product is “Made in U.S.A.” unless all or virtually all of the materials, processing, or component parts are made in the United States and their final assembly or processing took place there. All significant parts and processing that go into the product must be of U.S. origin. That is, the product should contain only negligible foreign content. For instance, the FTC has held that a gas barbecue grill assembled entirely from U.S. parts could be labeled as “Made in U.S.A.” despite the fact that the knobs were of foreign origin. The knobs were said to make up a small portion of the product’s total cost and an insignificant part of the final product.

The FTC origin rules apply also to other more indirect forms of marketing and promotion that may be deceptive. In one case, a company packaged its Chinese-made product in a package covered with an American flag and eagle. Despite the statement “Made in China,” which appeared in small print on the bottom and side panels of the package, the FTC held that the labeling was deceptive.

Partly Made in the U.S.A.?

Products that cannot be labeled as “Made in U.S.A.” may still bear qualified claims. A qualified claim is one that indicates that the product was partially made or processed in the United States. An example would be a down comforter labeled “Shell made in Germany with filling and further processing in the U.S.A.” To use a qualified claim, there must still be a significant amount of U.S. content. A product that is invented in the United States and made in India could not claim “Created in U.S.A.,” as this would be deceptive. The term “Assembled in U.S.A.” may be used only where the product has undergone a substantial transformation in the United States and where the use of the term would not be deceptive. For example, according to the FTC, component parts for computers made in Singapore and assembled in Texas with only a screwdriver and screws may not be labeled as “Assembled in U.S.A.” Here there was no substantial transformation in the United States and the statement is deceptive.

U.S. TRADE PREFERENCES FOR DEVELOPING COUNTRIES

Trade preferences, such as reduced tariffs or duty free status, are granted to developing countries to help further their social and economic development. Most developed nations, including the United States, Canada, Japan, and the European Union, grant trade preferences to developing countries, not only in their own hemispheres but also around the world. Four important U.S. programs for developing countries are the Generalized System of Preferences, the

Caribbean Basin Initiative

, the African Growth and Opportunity Act, and the Andean Trade Preference Act.

The Generalized System of Preferences

Under the Generalized System of Preferences (GSP), the United States aids in the economic development of certain developing countries by allowing their products to enter the United States at reduced rates of duty, or duty-free, until such time as these countries establish their own competitive industries. Such a trade preference is allowed under the terms of GATT and is similar to programs that other industrialized nations offer developing countries (notably the preferences granted by European nations to the products of many African nations). The program was begun in the United States in 1976 and has been renewed regularly by Congress. Mexico no longer qualified for the GSP when it joined NAFTA in 1994. There are approximately 130 countries eligible for GSP status. In 2009, imports worth over $20 billion entered the United States duty-free under the GSP.

Eligibility for GSP Status.

In order for a country to be eligible for GSP status, it must be designated a beneficiary developing country. Countries are not eligible for GSP status if they (1) have participated in an organized embargo of oil against the United States, (2) do not cooperate with the United States in the enforcement of narcotics laws, (3) aid and abet international terrorism, (4) have unlawfully expropriated the property of U.S. citizens, (5) do not recognize or enforce the arbitral awards of U.S. citizens, or (6) are controlled by communist governments. In addition, the president has wide authority under the GSP statute to deny duty-free treatment on political and economic grounds. For instance, the president can deny GSP status to any country that does not protect the patents, trademarks, and copyrights of U.S. citizens; maintains unreasonable restrictions on U.S. investment; does not grant internationally recognized worker rights to its workers; or whose exports to the United States injure a U.S. industry.

The product must also be eligible for duty-free treatment; about 5,000 types of products are eligible. Many of the eligible products are agricultural. A few examples of typical products admitted under the GSP include sugar, jewelry, leather shoe uppers, wooden furniture, Christmas tree lighting, and telephones. Certain importsensitive products, such as textiles, footwear, steel, watches, and some electronic items, are not eligible.

A country may lose GSP benefits for specific products under competitive need limits. Competitive need is determined by an annual review process conducted on a product-by-product basis. Usually the duty-free status of a country’s product will be terminated when more than half of the total U.S. imports of that product are imported from one GSP country or when imports of that product from the GSP country exceed a dollar level established by Congress. Competitive need limits do not apply to sub-Saharan Africa. U.S. firms, labor unions, and even foreign governments may petition that products be added to or removed from the GSP list.

Once a developing country reaches a per capita gross national product of $8,500, it becomes ineligible for GSP treatment and is considered to have graduated. By the close of the 1980s, the four “Asian tigers” of Hong Kong, Singapore, South Korea, and Taiwan had graduated from the GSP.

GSP Rules of Origin.

In order for an article to qualify for duty-free treatment, it must meet the following requirements: (1) it must be imported into the United States directly from the beneficiary developing country; (2) it must be the “growth, product, or manufacture” of the beneficiary developing country (or substantially transformed there into a product with a new name, character, and use); and (3) at least 35 percent of the value of materials and the direct cost of processing operations must have been added to the article in a single beneficiary developing country (or in any two or more GSP countries that are members of the same free trade association, such as ASEAN, CARICOM, or the Andean Group). A special rule applies when raw materials are brought to the GSP country from another country and then made into a finished article and shipped to the United States. In this case, the law requires a dual transformation. The raw materials brought from another country into the GSP country must first undergo a substantial transformation in the GSP country, resulting in a new and different article of commerce, in order for that article to be included in the 35 percent value content requirement. Then that article must undergo a second transformation into another new and different article of commerce, which is then shipped to the United States.

To better illustrate, consider the following example of a dual transformation adapted from the Code of Federal Regulations:

A raw, perishable skin of an animal grown in a nonbeneficiary country is sent to a beneficiary country where it is tanned to create nonperishable leather. The tanned leather is then cut, sewn, and assembled with a metal buckle imported from a nonbeneficiary country to create a finished belt that is imported directly into the United States. Because the operations performed in the beneficiary country involved both the substantial transformation of the raw skin into a new or different article (tanned leather) and the use of that intermediate article in the production or manufacture of a new or different article imported into the United States, the cost or value of the tanned leather used to make the imported article may be counted toward the 35 percent value requirement. The cost or value of the metal buckle imported into the beneficiary country may not be counted toward the 35 percent value requirement because the buckle was not substantially transformed in the beneficiary country into a new or different article prior to its incorporation in the finished belt.

Caribbean Basin Initiative

America’s leading imports from the Caribbean include petroleum products, chemicals, natural gas, textiles and apparel, agricultural products such as coffee and tropical fruits, electrical parts, and many others. According to the U.S. Department of Commerce, total U.S. imports from the Caribbean in 2008 were about $19.6 billion. The Caribbean Basin Initiative (CBI) is the name collectively given to several laws that grant trade preferences to aid the Caribbean countries. These are the Caribbean Basin Economic Recovery Act, the Caribbean Basin Trade Partnership Act, and the

Haiti

an Hemispheric Opportunity through Partnership Encouragement Act (the HOPE Act). These give the president the authority to grant tariff reductions or duty-free status to imports from eligible countries in order to encourage trade and investment in the Caribbean. The CBI countries, as of 2007, were those shown in Exhibit 12.5. A few of the other products benefiting from the preferences are cigars, cane sugar, communications equipment, electrical and non-electrical machinery, medical appliances, orange juice, bananas, ethyl alcohol, baseballs, and rum.

Exhibit 12.5: Caribbean Basin Beneficiary Countries (2010)

Antigua and Barbuda

Aruba

Bahamas

Barbados

Belize

British Virgin Islands

Dominica

Grenada

Guyana

Haiti

Jamaica

Montserrat

Netherlands Antilles

Panama

St. Kitts & Nevis

St. Lucia

St. Vincent & the Grenadines

Trinidad & Tobago

Many CBI countries, but not all, also qualify for benefits under the GSP. However, the criteria are not the same for product eligibility. Unlike the GSP, the Caribbean program has no provisions for graduating Caribbean countries on the basis of any economic criteria. The CBI applies to a greater variety of products than the GSP, and the competitive need requirements of the GSP are not applicable. This is a permanent program with no expiration date. However, the president must certify that each eligible country is recognizing the rights of workers to collective bargaining; eliminating child labor abuses; setting a minimum age for employing children; setting an acceptable minimum wage; and establishing acceptable hours of work and occupational safety and health standards.

Caribbean Rules of Origin.

Caribbean preference rules of origin are similar to those of the GSP. In addition, Caribbean preferences include duty-free entry into the United States for articles that have been “assembled or processed” in eligible countries from U.S.-made “components, materials, or ingredients.” In other words, U.S.-made parts may be subjected to minor assembly, finishing, and processing operations in a Caribbean country, and then shipped back to the United States for duty-free entry. For these products, the substantial transformation requirement has been eliminated.

Africa Growth and Opportunity Act

The Africa Growth and Opportunity Act (AGOA) was intended to aid in the economic growth and the establishment of political freedom in forty-eight poor countries in sub-Saharan Africa where the per capita annual income averages about $500 per year. The law encourages U.S. trade and investment there and improves access for African products to U.S. markets. To qualify for the benefits of the act, the African countries must try to improve their own conditions through progressive economic and social policies. The country must abide by human rights standards, eliminate abuses of child labor, and not support terrorism. Forty-seven countries are now eligible. AGOA grants preferences even more favorable than the GSP. It includes duty-free status for 6,500 eligible products. The largest AGOA sectors are petroleum, minerals (including platinum and diamonds), motor vehicle parts, steel, textiles, jewelry, fruit and nuts, leather, and cocoa. U.S. imports of AGOA products in 2008 totaled over $86 billion. About 60 percent of these came from Nigeria and Angola.

In order to qualify for AGOA preferences, an article must be produced or manufactured in an AGOA country and meet the rules of origin. For most products, the rules are similar to, but more lenient than, the GSP rules with which you are already familiar. African-made apparel generally qualifies for duty-free treatment if it is made from African-or U.S.-made fabric that was woven from U.S.-made yarn and assembled with U.S.-made thread or made from fabrics in short supply (linen, silk, batiste, velveteen, and some others).

U.S.-Andean Trade

The Andean Trade Preference Act program is part of an effort by the United States to promote economic development in the Andean countries while combating drug trafficking and encouraging democracy. The countries currently receiving benefits are Peru, Colombia, and Ecuador (Bolivia was removed in 2009), and their major exports are natural gas, minerals, certain metal products (copper, zinc, etc.), jewelry, forest and wood products, coffee, cocoa, fruits and vegetables, cut flowers, sugar, handicrafts, leather accessories, footwear, and textile products, to name a few. The program permits the duty-free import of almost 6,000 different kinds of products into the United States. The program was renewed by the U.S. Congress in the Andean Trade Promotion and Drug Eradication Act of 2002. In 2009, U.S. firms exported $16.7 billion to the three countries, invested $16.1 billion there, and imported over $21 billion in Andean goods covered by the program.

There is a movement toward supplanting the Andean trade preference program with a U.S.-Andean free trade agreement. The trade agreement would require that the Andean countries open their markets to U.S. goods, a notion not always popular in South America. Also, a free trade agreement would cover other topics, such as intellectual property, government procurement, the environment, labor issues, and dispute settlement. As of 2010, the United States-Peru Trade Promotion Agreement was already in effect. A similar agreement was negotiated with Columbia, but not yet passed by Congress because of the recent murders of labor organizers and civil rights violations in Columbia.

United States-Central America-Dominican Republic Free Trade Agreement

In 2005, the United States entered into a free trade agreement known as CAFTA-DR with Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the island nation of the Dominican Republic. Unlike the GSP and other programs just mentioned, CAFTA-DR is not a trade preference program, but a free trade agreement based on reciprocity and mutual agreement. According to the U.S. Department of Commerce, the agreement will result in duty-free status for over 80 percent of U.S. goods shipped there, with remaining tariffs phased out over five to ten years (fifteen years for agricultural products). The agreement also addresses many collateral issues, such as corruption, labor standards, environmental protection, and the protection of intellectual property. CAFTA-DR has its own rules of origin. In 2009, the U.S. imported $18.8 billion worth of products from CAFTA-DR countries, while exporting $19.9 billion to them.

OTHER CUSTOMS LAWS AFFECTING U.S. IMPORTS

This section examines two other laws affecting U.S. imports: drawback provisions allowing a refund of duties paid, and foreign trade zones.

Drawbacks

A drawback is a refund of duties already paid. The most common type is the manufacturing drawback, designed to encourage U.S. manufacturers to export. A manufacturing drawback is a 99 percent refund of duties and taxes paid on merchandise that is imported, subjected to manufacture or production, and then exported within five years. U.S. firms are becoming increasingly sophisticated in using manufacturing drawbacks. For instance, duties paid on imported yarn will be refunded to the importer who exports a finished fabric made from that yarn. Similarly, a poultry farm that imports chicken feed can receive a drawback on duties paid on the imported feed when the chickens are slaughtered and exported. Drawbacks such as these allow the exporter to purchase materials from low-cost foreign suppliers, including non-MFN countries, without having to pay prohibitively high duties. The use of drawbacks in U.S.-Canadian trade was eliminated in 1996. In U.S.-Mexican trade, drawbacks have also been eliminated.

Same-condition drawbacks are utilized when the imported goods are not processed or manufactured, but are reexported in the “same condition” as they were imported. These products are not significantly altered while in the United States (although they may be repackaged, cleaned, tested, or displayed). For example, nuts and bolts can be entered in bulk and sorted and repackaged in packages with foreign-language labeling. On export, the drawback applies. Many trading companies utilize same-condition drawbacks.

In certain cases, an importer may export U.S.-made goods in the substitution of imported goods that are of the “same kind and quality” (i.e., interchangeable) and receive the drawback on the imported items. This practice is known as a substitution drawback. In most instances, these substitution drawbacks deal with fungible goods or commodities such as agricultural products. Substitution drawbacks are applicable to both manufacturing and same-condition drawback situations. For instance, assume that a U.S. manufacturer imports semiconductors for use in making computers. The manufacturer may receive a drawback on duties paid if it exports, within three years, products containing U.S.-made semiconductors of the same kind and quality. If the company exports only 40 percent of its production, it can claim a drawback for 40 percent of the duties paid (a manufacturing/substitution situation). To take another example, the importer of soda ash can decide to resell the foreign soda ash in this country and export the same quantity of U.S.-made soda ash to a foreign buyer; the importer then can receive a drawback on duties paid on the imported soda ash (a same-condition/substitution situation).

A drawback of 99 percent is also allowed for imported merchandise that does not conform to specifications or to samples (e.g., zippers that do not zip; receipt of cotton sweaters instead of wool), provided that the error was the fault of the foreign shipper (not the importer) and the merchandise is returned to U.S. Customs within ninety days for inspection and returned to the seller under Customs supervision. A similar drawback is allowed for merchandise shipped to a U.S. firm without its consent. If a U.S. firm imports foreign goods and finds that they are useless and cannot be returned, the importer can receive a drawback on the duties paid on the merchandise, which is subsequently destroyed.

A drawback is essentially a contract with U.S. Customs. Firms wishing to arrange a drawback need competent advice in doing so. The procedures, time limits, documentation, and accounting requirements for obtaining all drawbacks are complex and exact, and many U.S. companies use the services of specialist firms for advice on structuring drawback transactions. Some firms utilize specially developed software to help track and document a drawback transaction. Civil penalties are imposed for violating the provisions of the law. Many firms do not file for drawbacks for fear of being assessed a penalty for clerical errors. The criminal penalties for fraudulently claiming a drawback are severe.

Foreign Trade Zones

Foreign trade zones (FTZs) are legally defined sites within a country that are subject to special customs procedures. They are monitored by, and under the control of, the customs authorities of that country. Foreign trade zones exist under the laws of most nations, including the United States. In the United States, FTZs operate under a license from the Foreign Trade Zone Board and according to regulations of the board and of U.S. Customs and Border Protection. Foreign trade zones must be within a 60-mile radius of a U.S. port of entry. Imported goods may be brought into an FTZ without being subjected to tariffs until such time as the goods are released into the stream of commerce in the United States.

FTZs are operated by state or local governments, airports or seaports, or specially chartered corporations who charge private firms for their use. Originally, FTZs were intended to encourage U.S. firms to participate in international trade by providing a “free port” into which foreign-made goods could be transported, stored, packaged, and then reexported without the payment of import duties. Today, FTZs are used for many different purposes, ranging from warehousing to manufacturing. Goods may be assembled, exhibited, cleaned, manipulated, manufactured, mixed, processed, relabeled, repackaged, repaired, salvaged, sampled, stored, tested, displayed, and destroyed. Manufacturing may result in a change to the tariff classification of the goods only with permission of U.S. Customs. Retail sales are prohibited. The length of time that these goods can be held in a zone is not limited.

The flexibility offered to an importer through the use of FTZs provides many opportunities for creative importing strategies. For example, firms can ship goods to their zone duty-free and hold them for later entry and sale in the United States pending buyer’s orders or more favorable market conditions. Foreign goods can also be held for exhibition and display in the zone for unlimited periods without the payment of duties. Foreign goods that arrive damaged or defective may be destroyed without the payment of duties. Goods in an FTZ are not subject to quotas and may remain in the FTZ until the quota opens and their entry is permitted. Title to goods held in an FTZ may be transferred to another party without the payment of duties (although not to a retail customer for consumption outside of the FTZ). Opportunities for creative business planning are almost endless. For instance, in certain cases it is possible that foreign component parts can be assembled in an FTZ, making the duties payable when the finished product is sold less than what the duties would have been on the individual components. As another example, if a commodity is dutied by weight, it may be brought into an FTZ for drying; subsequently it may be entered without the excess weight caused by the moisture. But perhaps the most unusual use of an FTZ is the Cape Canaveral Zone in Florida. There, foreign payloads can be imported into the United States, processed and made ready for a space launch, and “exported” to space without the payment of U.S. import duties! Over two hundred general purpose foreign trade zones and more than two hundred and fifty subzones exist in the United States.

In addition to general purpose zones, firms are able to establish their own special purpose subzones. Subzones can be placed anywhere in the United States with U.S. Customs approval. Most automotive manufacturers and oil refineries use subzones. They are also widely used in chemicals, pharmaceuticals, computer assembly, electronics, and shipbuilding and as retail distribution centers. The following case, Nissan Motor Mfg. Corp. U.S.A. v. United States, arose out of Nissan’s importation of equipment into an automotive manufacturing subzone in Tennessee.

Nissan Motor Mfg. Corp., U.S.A. v. United States

884 F.2d 1375 (1989) United States Court of Appeals (Fed. Cir.)

BACKGROUND AND FACTS

Nissan operates a foreign trade zone subzone at its automotive manufacturing and assembly plant located in Smyrna, Tennessee. Nissan imported production machinery for use in the subzone consisting of industrial robots, automated conveyor systems, and a computerized interface. The machinery was to be assembled and tested in the zone, and if it proved unsatisfactory it was to be replaced, redesigned, or scrapped. Customs ruled that production equipment was not “merchandise” as defined under the FTZ act and was therefore dutiable. Duties were liquidated at $3 million and Nissan filed a protest. On denial, the Court of International Trade ruled that the equipment was dutiable, and this appeal was filed.

CIRCUIT JUDGE ARCHER

The activities performed by Nissan in the foreign trade zone subzone with the imported equipment are not among those permitted by a plain reading of the statute. Section 81c provides that merchandise brought into a foreign trade zone may be “stored, sold, exhibited, broken up, repacked, assembled, distributed, sorted, graded, cleaned, mixed with foreign or domestic merchandise, or otherwise manipulated, or be manufactured….”

The act does not say that imported equipment may be “installed,” “used,” “operated” or “consumed” in the zone, which are the kinds of operations Nissan performs in the zone with the subject equipment. Alternative operations of a different character should not be implied when Congress has made so exhaustive a list.

Nissan relies upon the case of Hawaiian Indep. Refinery v. United States, 460 F. Supp. 1249 (Cust. Ct. 1978), in support of its position. The merchandise there involved was crude oil which was entered into a foreign trade zone for manufacture into fuel oil products. This, of course, is an activity delineated by the act and entry into the zone was exempted from Customs duties. Thereafter, a portion of the crude oil was consumed in the manufacturing process and Customs assessed duty on the theory that there had been a “constructive” entry into the Customs territory of the United States. In holding that the assessment was improper, the Court of International Trade did not have to deal with the question at issue here of whether the initial entry into the zone was exempt. Clearly, in that case the crude oil was exempt at the time of entry. Thus, the Court of International Trade properly concluded that the Hawaiian Indep. Refinery case was not dispositive of this case.

We are convinced that the Court of International Trade correctly determined that the importation by Nissan of the machinery and capital equipment at issue into the foreign trade zone subzone was not for the purpose of being manipulated in one of the ways prescribed by the statute. Instead it was to be used (consumed) in the subzone for the production of motor vehicles. Under the plain language of the 1950 amendment to the act and the legislative history of that amendment, and Customs’ published decision interpreting the act as amended, such a use does not entitle the equipment to exemption from Customs duties. Accordingly, the judgment of the Court of International Trade is affirmed.

Decision. The decision of the lower court was affirmed. Machinery entered into a foreign trade zone for use in the manufacture and assembly of automobiles is not “merchandise” under the act and may not be entered duty-free.

Case Questions

1. What purposes do FTZs serve? Why did Congress establish them?

2. What were the advantages to Nissan by assembling automobiles in an FTZ? How many can you list?

3. Why could Nissan not bring manufacturing equipment into its zone duty-free? Do you think this case applies to office chairs or personal computers?

4. Assume that you import merchandise subject to annual quotas. You have a shipment arriving, but the quota has filled. How might an FTZ help you?

5. What FTZs are located in your state or region?

CONCLUSION

The Bureau of Customs and Border Protection is responsible for securing America’s borders from terrorist threat; interdicting illegal immigration, contraband, and narcotics smuggling collecting tariff revenue; enforcing the customs and tariff laws of the United States; and enforcing the export control laws. The importance of the agency has changed in recent years and will continue to grow as Americans focus more on the issue of illegal immigration, as the terrorist threat continues, and as increases in international trade result in greater amounts of cargo arriving at U.S. ports.

U.S. Customs recognizes its enforcement predicament: it must protect the borders of the United States while considering the needs of American importers and exporters for expedited customs entry and delivery and the impact of cargo delays on the U.S. economy. Given the numbers of ocean containers and international flights arriving at U.S. ports every day, most Americans recognize the immense job the agency has been given. They also recognize that the effective and efficient enforcement of the customs laws and the movement of cargo are largely dependent on their cooperation and partnership with customs officials.

All businesspeople must be concerned about complying with the customs and tariff laws of the countries in which they import or export. In the United States, as in other countries, enforcement actions and penalties for violations can be severe. Individuals and firms must adhere to the concept of informed compliance. This means that importers and exporters must use reasonable care in handling entries and must either be adequately trained or rely on trained professionals.

Finally, customs compliance does not mean that importers should not plan their business strategies to take advantage of opportunities in the customs and tariff laws. To the contrary, tariff laws, like many other types of tax laws, are intended to encourage and reward certain business decisions. Multinational companies that structure their global operations to take advantage of incentives in the customs or tariff laws or that source materials and products made in certain countries that have tariff preferences under U.S. law, for example, are simply taking advantage of business opportunities legally provided by Congress. Customs laws will affect where multinationals build their plants, where they source their materials or component parts, how they move goods from country to country, and how they structure their overall global operations. Careful customs planning is essential to the success of any international business plan.

Chapter Summary

1. A formal entry is the administrative process required to import goods into the customs territory of a country. The goods may be entered by the owner, purchaser, consignee (the party to whom the goods are shipped or to be delivered), or a licensed customs broker.

2. The Customs Modernization and Informed Compliance Act introduced the doctrine of informed compliance, which shifted a major responsibility to comply with all customs laws and regulations to the importer. It requires that importers use reasonable care in complying with the law, in handling all import transactions, and in preparing all documentation for entered goods. Reasonable care means more than simply being careful. It means that those handling import transactions must be properly trained, that companies must establish internal controls over import operations to ensure compliance, and that professional advice must be sought when needed.

3. Binding rulings from the Customs Service are an important tool in properly and safely planning import transactions in advance.

4. Most trading nations of the world utilize the schedules of the Harmonized Commodity Description and Coding System for classifying products. In the United States, the Harmonized Tariff Schedule is a federal statute that schedules virtually all goods sold in commerce and lists the tariff rate for each according to the country of origin.

5. Tariffs, restraints on imports, and other import controls are applied to goods according to their dutiable status. The dutiable status of goods is determined by the classification of the article, the transaction value of the article, and the country of origin of the article.

6. Goods are classified in the Harmonized Tariff Schedule either by name, by description of the article’s physical characteristics, by a description of their component parts, or by a description of the article’s use. Goods classified by name are defined by the common or popular meaning of the name, unless it is clear that Congress had intended the commercial or scientific name to apply. Anyone attempting to research the classification of an article in the HTSUS must follow the rules set out in the General Rules of Interpretation. Where an article may be classified under more than one heading, it must be classified under the one that most specifically describes the item. If two or more headings each describe only certain materials or components of the article, the article must be classified under the heading that describes those materials or components that give the article its essential character.

7. The dutiable value of the goods is the transaction value. This is the cost of the goods, adjusted for certain elements of cost set out in the statutes and regulations such as packing costs, assists, or royalty fees.

8. Rules of origin are the national laws and regulations of administrative agencies, usually customs authorities, which are used to determine the country of origin of imported products. There are few areas of customs law that are so complex and that are as difficult for importers to understand. One of the reasons for the complexity is that there are so many different rules applicable to imports from different countries. The general rule is that the country of origin of an imported article is that country where it was wholly and completely produced, manufactured, or obtained entirely from raw materials originating in that country. Where goods are not wholly the product of one country, such as goods assembled in more than one country, importers must rely on the substantial transformation test or tariff shift rules set out in the customs statutes and regulations.

9. Tariff preferences are laws that grant lower tariff rates on products imported from certain countries or regions. The most common tariff preference programs in the United States are the Generalized System of Preferences for developing countries, and regional programs for imports from the Caribbean, Africa, and the Andean region. Europe and other developed countries also have similar tariff preference programs.

Key Terms

importing 364

ports of entry 364

customs broker 365

formal entry 365

informal entry 368

liquidation 368

notice of adjustment 368

deemed liquidation 368

enforced compliance 372

informed compliance 372

binding ruling 374

dutiable status 375

harmonized tariff schedule 377

general rate of duty 378

special rate of duty 378

General Rules of Interpretation 383

rule of relative specificity 384

essential character test 384

tariff engineering 385

dutiable value 387

transaction value 387

production assist 388

contract manufacturing 388

rules of origin 389

country of origin 389

trade preference 389

substantial transformation 390

name, character, or use test 391

tariff shift rule 394

ultimate purchaser 395

Generalized System of Preferences 397

beneficiary developing country 397

competitive need 397

dual transformation 398

manufacturing drawback 399

same-condition drawback 400

substitution drawback 400

foreign trade zone 400

fair trade 406

Questions and Case Problems

1. Visit the Website of the Bureau of Customs and Border Protection. What resources does it contain for the trade community?

a. The Customs Rulings Online Search System (CROSS) is a searchable database of about 100,000 ruling letters. Try your hand at locating rulings on some of the issues discussed in this chapter. For example, enter “country of origin” together with the name of a product or class of products and see what you can find. Remember, these letters are binding only for the individual to whom they are written and only for that transaction. Nevertheless, they are interesting and helpful to importers that use this service frequently.

b. Go to the “Legal” section of the Website and look at the Customs Bulletins and Decisions. This is a weekly diary of all official acts of the agency. What type of information does it contain, and who might want to follow this on a regular basis?

c. Go to the Import section and look at the Container Security Initiative. Six million ocean containers enter U.S. ports every year. Only a tiny fraction can be inspected by hand. Any one of them could be used to hide a weapon of mass destruction. Look at the Customs-Trade Partnership Against Terrorism (C-TPAT), a process for enhancing security between U.S. importers and their foreign supply chains. How do you think the threat of terrorism and Customs’ security programs will affect global transportation in the years to come? What is Customs’ “24-hour rule” for loading cargo aboard ships destined for the United States?

2. Acquaint yourself with the Harmonized Tariff Schedules of the United States. Be sure that you understand how products and commodities are arranged in the schedules and that you know how to use the schedules. The schedules are maintained by the U.S. International Trade Commission and can be found at their Website or through a link on the Customs site. Be sure to find the full text of the law, which is arranged by chapter. (The schedules will appear in a pop-up box using PDF format files.)

a. Know how to use the General Rules of Interpretation and the General Notes.

b. Which countries receive GSP tariff preference treatment?

c. Which countries qualify for duty-free treatment as “least developed beneficiary developing countries?”

d. Which countries qualify for the Andean Trade Preference Act? The African Growth and Opportunity Act preferences?

e. A good portion of the HTSUS is devoted to the dutiable status of goods moving in North America. NAFTA is the subject of the next chapter. Can you locate the NAFTA rules of origin, known as the “tariff shift” rules, in the schedules?

f. Choose several products with which you are familiar, and attempt to classify them using the schedules.

3. The primary body of U.S. customs law is found in Title 19 of the United States Code. The regulations are found in the Code of Federal Regulations. You can access the CFR either through the Web site of the U.S. Customs and Border Protection (“Legal” section) or through the Government Printing Office site. Can you find Customs’ record-keeping rules? What are the rules for filing a protest with U.S. Customs? Can you find the rules of origin, including those for textile imports?

4. Inner Secrets entered 2,000 dozen boxer-style shorts from Hong Kong. The boxer shorts were made of cotton flannel in a plaid pattern, with a waistband that was not enclosed or turned over, a side length of 17 inches, and two small nonfunctional buttons on the waistband above the fly. Two seams were sewn horizontally across the fly, dividing the fly opening into thirds. The boxers did not have belt loops, inner or outer pockets or pouches, or button or zipper fly closures. They were marketed under the label “No Excuses.” Customs classified the garments as outerwear shorts under HTSUS 6204.62.4055: “Women’s or girls’ suits, ensembles, suit-type jackets and blazers, dresses, skirts, divided skirts, trousers, bib and brace overalls, breeches and shorts…. Trousers, bib and brace overalls, breeches and shorts… of cotton… 17.7%.” The Customs Service based its decision on its determination that the boxers will be worn by women as outer clothing. Inner Secrets maintains that the items are not outerwear, as Customs claims, but are actually underwear properly classified under HTSUS 6208.91.3010: “Women’s or girls’ singlets and other undershirts, slips, petticoats, briefs, panties, nightdresses, pajamas, negligees, bathrobes, dressing gowns and similar articles… of cotton… 11.9%.” Inner Secrets filed a protest with the agency, which was denied. Inner Secrets brought this action with the Court of International Trade. What is the proper classification of the boxers? How would a camisole worn under a sport jacket or a slip worn as a dress be classified? Inner Secrets v. United States, 885 F. Supp. 248 (Ct. Int’l. Trade 1995). See also St. Eve International v. United States, 267 F. Supp. 1371 (Ct. Int’l. Trade 2003).

5. Sports Graphics imported soft-sided “Chill” coolers from Taiwan. The coolers consisted of an outer shell of a vinyl-coated nylon material, an insulating core of approximately 1/2-inch-thick polymer-based closed cell foam, a top secured by a zippered interlocking flap, an inner liner of vinyl, a handle or shoulder strap of nylon webbing and plastic fixtures providing a means of carrying the merchandise, and exterior pockets secured by hook-and-loop or zippered closures. Customs classified the merchandise under the luggage provision, which included “Travel goods, such as trunks…satchels, suitcases, overnight bags, traveling bags, knapsacks…and like articles designed to contain…personal effects during travel…and brief cases, golf bags, and like containers and cases designed to be carried with the person…Luggage and handbags, whether or not fitted with bottle, dining, drinking… or similar sets…and flat goods…of laminated plastics…” at a 20 percent rate of duty. Sports Graphics contended that the imported soft-sided coolers were properly classifiable as “Articles chiefly used for preparing, serving, or storing food or beverages” and were dutiable at a rate of 4 or 3.4 percent ad valorem. What is the proper classification? Does the use of this product have a bearing on its classification? Is the chief purpose to serve as “travel goods” or to “serve or store food or beverages”? Sports Graphics, Inc. v. United States, 24 F.3d 1390 (Fed. Cir. 1994).

6. You intend to import raw, frozen calamari (squid) from China, Vietnam, and Peru into the United States, where it will be defrosted and tenderized. The tenderization process entails placing the imported squid into a solution consisting of ice water mixed with salt, citric acid, sodium citrate, active oxygen, and potassium carbonate. The squid is kept at a temperature of 32 to 36 degrees Fahrenheit as it sits in the solution within a large tank for a period of 15 to 18 hours. The process does not change the size or shape of the calamari, but makes it whiter and plumper. Then it is washed with clean water before being refrozen and repacked for sale. Can your calamari be labeled “Product of U.S.A.”? Why or why not? Can you locate any cases like this in the Customs Rulings Online Search System?

7. You intend to import vodka that is produced in Denmark. The strength of the vodka when imported will be at least 80 percent by volume. In the United States, the vodka will be diluted with water, sugar, and flavor to produce flavored vodka with 35 percent alcohol by volume. What is the correct country of origin for labeling purposes? Why?

8. You intend to obtain a saw blade produced in England, ship it to China to be assembled with a handle that is manufactured in China. The finished saw is then packaged in China for export. What is the country of origin of the saw? Why?

Managerial Implications

Your firm is one of the last remaining manufacturers of bicycles in the United States. Z-Mart is a U.S. retail chain with nearly 1,000 stores in fifteen countries. Z-Mart has asked you to prepare a proposal for a large number of bicycles to be sold at discount prices under the Z-Mart brand name. They must have a U.S. retail price of no more than $100. Z-Mart would also like to sell these bikes through its stores in France and Italy in order to compete with the European bikes made in that market. You begin to analyze your costs of materials and production. The first step of production is the sourcing of a tubular frame, a major component. You can purchase the bare frames in the United States, Canada, or Taiwan. You must clean and paint the frames before assembly. The high-performance wheels, another major component, are made from an aluminum alloy. The aluminum is made in Japan and shipped in the form of strips and rods to the Philippines, where it is cut into lengths, molded into wheel parts, and assembled. They will arrive at your plant covered in a film of oil to protect them during shipping. The tires are available from companies in Japan or Brazil. Most of the component parts, such as brakes, gears, and chains, are available directly from firms in the United States and Canada.

At a meeting of management, you are asked to prepare a plan for the production of the bicycles that will price them for Z-Mart’s discount stores. In doing so, you must give consideration to the following questions. (You may make certain assumptions as to the relative costs of materials and labor if necessary.)

1. Explain how U.S. trade and tariff laws would affect your plans for bicycle production. What influence would U.S. tariff preference laws have on the sourcing of component parts? Explain how the rules of origin might affect the importation of the tubular frame. Would NAFTA have any impact on how you structure your operations?

2. What factors would be taken into consideration in determining whether to assemble the finished bicycles in the United States, Taiwan, or the Philippines? You have heard that U.S. automakers are assembling cars in Mexico using workers that are paid about $20 a day. What factors would influence your decision to assemble in Mexico? What processes could you do or not do in Mexico in order to obtain the most favorable tariff treatment? What are the advantages and disadvantages of assembling there?

3. Evaluate the potential for using a foreign trade zone. What advantages or disadvantages would your firm experience in this case?

4. Determine the applicability of U.S. marking and labeling requirements with regard to the finished bicycles sold in the United States.

Ethical Considerations

Fair Trade is a worldwide movement based broadly based on the theory that trade between rich and poor should be based on notions of social and economic justice, and which advocates that small farms and farm workers in developing countries receive a fair price in return for their agricultural and handicraft products. Although the fair trade movement dates to the 1940s, it became popular in parts of Europe in the 1960s and more recently has taken hold in the United States. Fair trade is supported by consumers willing to pay a small additional price for goods knowing that the indigenous producers of the goods, living and working under the poorest conditions, received a fair price for their product. Some fair trade farms consist of small cooperatives, with individual families farming only a couple of acres. Typical fair trade products include coffee, tea, bananas, wine, herbs and spices, honey, rice, and cocoa. Standards, minimum prices, inspections, and certifications of producers and traders are the responsibility of private, nonprofit organizations. Fair trade standards also require that certified farms practice sustainable farming techniques, follow rules on the use of pesticides and recycling, refrain from using child labor, and encourage farm children to attend school. These advances are made possible by the higher prices participants receive for their products.

By the early 2000s, labeling standards for fair trade-certified products became standardized, so that consumers could recognize fair trade products in stores. Participants in fair trade include the workers and producers themselves, the brokers and traders who deal in the products, the retailers and vendors in richer countries, and consumers. Some of the most important fair trade organizations are the Fairtrade Labelling Organizations International, the European Fair Trade Association, the International Fair Trade Association, and TransFair USA.

1. Would you be willing to pay a slightly higher price for sugar, coffee, fruits, and basic commodities, knowing that their producers, farmers in Central America or Africa, were paid an internationally established “fair price” for their labors? Do you believe that consumers will make ethical choices in the marketplace, or economic ones?

2. Fair trade is based on the guarantee of a fair price. How is a “fair price” determined? What is the role of independent fair trade organizations in establishing price?

3. Critics suggest that fair trade does not address the root causes of poverty. Some economists argue that low prices for basic commodities, like coffee, result from oversupply. Moreover, fair trade also does not guarantee access to investment or technology. Do you think the fair trade movement can be successful in rooting out poverty?

4. Although fair trade products account for a tiny volume of world trade relative to the total volume, they do focus concern on the plight of poor farmers, farm workers, and producers in agrarian regions. Some of America’s largest and best-known retailers are selling fair trade products, including Sam’s Club, McDonald’s, Dunkin’ Donuts, Starbucks, and many grocery chains. Based on your research and outside reading, what do you think the impact of fair trade programs can be?

(Schaffer 364)

Schaffer, Agusti, Dhooge, Earle. International Business Law and Its Environment, 8th Edition. South-Western, 2011-01-01. .

CHAPTER 13: The Regulation of Exports

Throughout history, every civilization has had to decide whether it will trade with outsiders, and if so, on what terms. After all, there were economic, political, and military interests to protect. There were outlaw tribes and evil princes to punish. What better way than to deprive them of goods and treasures, be they coveted spices, colorful dyes, or prized horses. There were state-of-the-art technological secrets to guard. From the secrets of steelmaking and the fashioning of swords and armor, to the invention of gunpowder and the bow and arrow, to the addition of the lowly stirrup to a horseman’s saddle, technology has turned the tide of many battles and the course of history. Empires have been won or lost because of the technological advantage of one warrior, or one army, over another. The warlords and kings of ancient Europe and Asia knew this well and meted out punishments of torture and death to those who disclosed such closely guarded secrets or traded with the enemy. Imagine the diplomatic couriers of the ancient world, or medieval statesmen of later periods, who went out on foot or on horseback to distant kingdoms. They arranged alliances and orchestrated embargoes of common enemies. These were times of secret treaties, encrypted messages, intrigue, and danger.

This could just as well be the story of the modern world. Trade is still used to reward allies and punish outlaw nations. Civilized people still war with barbarians and deny aid and comfort to those who harbor them. Advances in technology are still guarded from foreign enemies. There are, perhaps, a few differences. Today’s outlaw nations are violators of human rights; the barbarians are called “terrorists”; the advances in technology involve computers, software for missile guidance systems, stealth technology, and the materials and know-how to destroy entire cities; and secret treaties have been replaced by international conventions and United Nations resolutions.

The primary subject of this chapter is how nations use policy and regulations to control exports to foreign countries for purposes of national security and foreign policy. Our focus will be on the system and methods used by the United States. Much of the discussion would apply equally to Canada or the European Union, although the overarching policies of each nation may be different. In the United States, there are two main, overlapping regulatory systems for controlling exports of goods and technology. The first, which we will study only briefly, is concerned with the control of arms, munitions, and defense systems. This system is primarily administered by the munitions list Department of State. The second, which is the one that we will be most concerned with, is the system of controls over nonmilitary commercial goods, commodities, and technology. These controls, too, can function as tools of national security or foreign policy. (In this chapter, controlled goods or technologies are those that require a license for export.) This system is primarily administered by the United States Department of Commerce. In both systems, the lead agencies coordinate with the Department of Defense (for military equipment and defense systems), the Department of Energy (for nuclear technology), the Department of Homeland Security (for customs and border enforcement), and other federal departments and law enforcement agencies.

We will also look at the larger issues of trade policy. Should a nation continue to trade goods and basic commodities, even food, with totalitarian governments that engage in slavery or other human rights abuses, harbor terrorists, or manufacture chemical or biological weapons? Do unilateral controls or multilateral trade sanctions work against rogue nations? How are those controls and sanctions implemented in the United States? How does a munitions list exporter obtain a license to ship controlled goods or technology? What extraordinary powers has Congress given to the president, in war and peacetime, to address perceived international emergencies? What are boycotts, and how do munitions list companies comply with antiboycott laws? Finally, what is business expected to do in terms of internal and external compliance, and what civil and criminal penalties does the government use to enforce the export control laws?

As you read, keep in mind that no person in any country has a guaranteed legal right to export. In the United States, there is no constitutional right to export, although the Constitution protects procedural due process rights. Exporting is considered a privilege that can be granted or revoked according to law.

TRADE CONTROLS OVER ARMS, MUNITIONS, AND DEFENSE SYSTEMS

Advanced nations control the sale of arms, military hardware, weapons and defense systems, and related technologies as means of maintaining military superiority and honoring defense treaty commitments, as well as for strategic reasons. They can deny military technology to their enemies or potential enemies and share it with their friends or military allies. Well-known examples include America’s defense commitments to the countries of the North Atlantic Treaty Organization (NATO) and to Israel, Taiwan, Japan, and South Korea. Arms controls are also used to keep weapons from certain war-torn regions of the world and from countries that are experiencing civil war or rebellion, or threatening their neighbors. On the other hand, an arms-exporting country can approve arms sales to countries that cooperate in its foreign policy objectives, such as helping to eradicate and interdict traffic in narcotic drugs or capture terrorists. Most governments strictly regulate these transactions and limit them to registered and licensed firms. Countries also strategically coordinate their export controls over arms, munitions, and weapons systems.

The Neutrality Acts

In the United States, the modern system for controlling both exports and imports of armaments derives from a series of statutes enacted in the mid-1930s, known as the Neutrality Acts. These statutes were passed by a Congress intent on keeping the United States out of war in Europe by controlling the export of arms and ammunition. At the time, the government placed arms exports under the direction of a newly created National Munitions Control Board, consisting of five cabinet secretaries and chaired by the secretary of state. Although that board no longer exists, the system established in the 1930s was the direct predecessor of the arms export control system used in the United States today.

The Arms Export Control Act

The Arms Export Control Act (AECA) governs the export and import of “defense articles” and “defense services” (including arms, munitions, weapons systems and defense systems, and their technologies) and communication of technical data to foreign persons. The act is administered according to the International Traffic in Arms Regulations (ITAR) by the Directorate of Defense Trade Controls, a branch of the munitions list Department of State. These regulations include the U.S. Munitions List, which identifies those categories of equipment and technologies subject to export control. To be on the list, an item must be either “specifically designed… or modified for a military application” and not have “predominant civil applications” or have “significant military or intelligence applications such that control is necessary.” The regulations also list countries that are prohibited from receiving U.S. arms or defense technology, such as state sponsors of terrorism and countries subject to United Nations sanctions.

The ITAR regulations require registration by firms and individuals engaged in manufacturing, brokering, importing, or exporting military articles or services. In part, registration is intended to disclose if an applicant company is under foreign ownership or control. License applications for the export of advanced weapons and defense systems go to the Department of Defense for technical review. Congress must be notified in advance in the case of some larger transactions.

In 1999, the authority to control exports of commercial satellites and spacecraft was transferred from the Department of Commerce to the Department of State, under ITAR. It was intended to help safeguard those technologies. But the result has been that U.S. firms have lost a significant amount of the commercial satellite business to foreign firms, including to the Chinese. In recent years there have been many calls from industry to loosen controls on satellites and return the authority to the Department of Commerce.

The following case, B-West Imports, Inc. v. United States, involves an American importer of arms from China whose permits had been unexpectedly revoked on foreign policy grounds. Although the case involves the import of arms, rather than export, it represents a larger principle: One’s right to engage in the import or export of arms, munitions, and other highly regulated products is subject to near-absolute control by government authorities.

NATIONAL SECURITY AND FOREIGN POLICY ISSUES

Nations restrict exports of goods and technology for many policy reasons. The three most important reasons are to protect national security, to implement foreign policy, and to limit the sale of critical goods and strategic raw materials that are in short supply. Other reasons include regulating the export of fish, wildlife and endangered species, hazardous waste, and nuclear materials intended for energy purposes, preserving antiquities and cultural objects, and promoting other national goals.

B-West Imports, Inc. v. United States

75 F.3d 633 United States Court of Appeals (Fed. Cir. 1996)

BACKGROUND AND FACTS

The U.S. Arms Export Control Act (AECA) prohibits the import of arms and munitions from countries on the “proscribed list” without a license. Although China had been on the proscribed list, prior to 1994 exemptions had been made for China and import licenses issued. On May 26, 1994, however, President Clinton announced a ban on the import of arms and munitions from China and imposed other trading sanctions because of “continuing human rights abuses” and other foreign policy reasons. The law was enforced by the U.S. Customs Service and the Bureau of Alcohol, Tobacco, and Firearms (BATF). The agencies detained all shipments of arms from China and revoked all import permits. B-West Imports (the appellants), together with nine other importers, challenged the government’s actions in the Court of International Trade. They argued that the AECA does not authorize the president or his delegates to impose an arms embargo and that the revocation of the permits violated the due process and takings clauses of the Fifth Amendment to the Constitution.

BRYSON, CIRCUIT JUDGE

In this court, the appellants renew their argument that the AECA does not authorize an arms embargo. Although the Act, 22 U.S.C. §2778, grants the president the authority to “control” arms imports, the appellants argue that the term “control” limits the president to creating and operating a licensing system for arms importation, and does not allow the president to ban the importation of arms for which import permits have been granted.

The appellant’s statutory argument is unconvincing. They concede that the term “control” is broad enough to allow the president to ban imports by denying licenses or permits for future imports. Their contention is thus limited to the assertion that “control” does not include the right to revoke licenses and permits after they are granted…. As the court noted in South Puerto Rico Sugar Co. v. U.S., 167 Ct.Cl. 236, 334 F.2d 622 (1964), presidents acting under broad statutory grants of authority have imposed and lifted embargoes, prohibited and allowed exports, suspended and resumed commercial intercourse with foreign countries. Thus, the broad statutory delegation in the AECA incorporates the historical authority of the president in the fields of foreign commerce and of importation into the country. We therefore agree with the Court of International Trade that the AECA authorizes the president not only to regulate arms importation through a licensing system, but also to prohibit particular importations altogether when the circumstances warrant….

Finally, the appellants challenge the government’s actions as violative of the Takings and Due Process Clauses of the Fifth Amendment. In the Legal Tender Cases, 79 U.S. (12 Wall.) 457 (1870), the Supreme Court rejected just such an argument, noting that an embargo would not give rise to a compensable taking or a valid due process claim:

A new tariff, an embargo, a draft, or a war inevitably bring upon individuals great losses; may, indeed, render valuable property almost valueless. They may destroy the worth of contracts. But whoever supposed that, because of this, a tariff could not be changed, or a non-intercourse act, or an embargo be enacted, or a war be declared…. [W]as it ever imagined this was taking private property without compensation or without due process of law? Id. 79 U.S. (12 Wall.) at 551.

While it is true that takings law has changed significantly since 1870, the principles that the Supreme Court articulated in the Legal Tender Cases have remained valid, particularly as they apply to governmental actions in the sphere of foreign relations….

The same principle is directly applicable here. While an individual who obtains a permit to import arms may make commitments in the arms market on the assumption that the permit will not be revoked before the importation is completed, that assumption does not constitute a “reasonable investment backed expectation” of the type necessary to support a takings claim. That is particularly true with respect to importations of arms from a country with which the United States has an arms embargo that is subject to an exemption that could be terminated at any time.

The appellants’ due process claim fares no better. They assert that the implementation of the Chinese arms embargo deprived them of property without due process of law by denying them the opportunity to sell in the United States the munitions for which they had obtained permits prior to the announcement of the embargo. As we have discussed, however, the appellants’ right to import and sell Chinese arms in the United States was subject at all times to the hazard that their permits would be revoked, pursuant to statute and regulation, on foreign policy grounds or for other reasons. The Due Process Clause does not require the government to stand as a surety against the adverse consequences sometimes suffered by persons who knowingly undertake that kind of commercial risk.

Decision. Judgment affirmed for the United States. Under the Arms Export Control Act, the president has wide latitude to enforce this law by prohibiting the import of controlled items. A statute that deprives one of the opportunity to import goods does not violate or “take” one’s property under the Fifth Amendment without compensation, nor does it deprive the importer of due process of law.

Case Questions

1. Why did the president ban imports of arms from China?

2. On what grounds did the importers challenge the ban? Is there a difference between “controlling” imports and “prohibiting” them?

3. In what way did the court rely on the “historical authority of the president in the fields of foreign commerce”?

4. Why did the court reject the importer’s Fifth Amendment argument? If it had not, what would have been the impact on the ability of the government to conduct foreign relations? Could it have opened the “floodgates” of litigation?

5. Can the government revoke a license to import or export after it has already been issued?

Trade Controls for Reasons of National Security

In the United States, national security controls restrict exports of goods or technology that could make a significant contribution to the military capabilities of any other country and would prove detrimental to the national security of the United States. They are enforced by a licensing system administered by the U.S. Department of Commerce, in cooperation with the Department of Defense, which receives and approves licenses for exports of goods or transfers of technology on a case-by-case basis. License applications are evaluated for compliance with the law based on the product or technology, the end user, and the country of destination.

Trade Controls for Reasons of Foreign Policy

Nations often grant or deny trade privileges to further their foreign policy objectives. Foreign policy controls are the “carrot and stick” of diplomacy. In the United States, foreign policy controls are used for many reasons. Here are a few broad types of reasons:

• To suppress terrorism and to deny aid and assistance to individuals, groups, or nations that sponsor it

• To punish repressive governments for human rights violations and encourage change

• To end regional conflict or civil war

• To fulfill treaty obligations

• To carry out United Nations-sponsored trade sanctions

• To keep crime control and detection equipment out of the hands of repressive regimes

• To encourage countries to eradicate and interdict illegal narcotics

• To stop the proliferation of nuclear technology and weapons of mass destruction

• To prohibit an introduction of strategic goods or technology to a region of the world if that introduction would upset the balance of power among countries in the region

• To limit the spread of missile technology

• To deny aid and assistance to communist governments (less important today than in past decades)

As of 2010, the United States had strict foreign policy trade controls, as well as restrictions on investment and travel, relating to five countries deemed to be “state sponsors of terrorism.” These were Cuba, Iran, Sudan, and Syria. Placing a country on or off the list can be a foreign policy bargaining chip. For example, President Bush removed North Korea from the list when it agreed to dismantle its plutonium processing plant. As North Korea became more provocative, the United States later threatened to put it back on the list. A sixth country, Libya, recently came off this list, having renounced all attempts to possess weapons of mass destruction and opened its facilities to international inspections.

The Effectiveness of Trade Sanctions

The use of trade controls to accomplish foreign policy objectives has been a subject of great political and economic debate. Proponents of the use of trade sanctions argue that they are often effective, that they bring international attention to important world issues, and that they assert a moral stance. As examples, proponents point out that trade sanctions helped to end the civil war in the former Yugoslavia and drew worldwide attention to the plight of repressed people in Western Africa, funded by the sale of so-called “blood diamonds.” They also point out that the imposition on Libya of international and U.S. sanctions (including bans on trade, investments, and travel) for harboring two terrorists accused of shooting down Pan Am flight 103 over Lockerbie, Scotland, in 1988, eventually led to Libya handing over the suspects for trial.

Those who argue against the use of trade sanctions say that they are ineffective. They point out that imposing economic sanctions on an already poor country often affects innocent people more than it does those in power. Economic sanctions alone are rarely enough to cause a repressed people to rise up against a brutal military government. Most people would agree that almost fifty years of U.S. restrictions on trade with and travel to communist Cuba have done nothing to remove the Castro government or change its policies. Others argue that the Cuban sanctions did not work because they were not tough enough. Another argument against sanctions is that they are often easy for the targeted country to circumvent. Without universal cooperation, which there seldom is, sanctions quickly lose their effectiveness.

United Nations–Approved Sanctions.

Trade sanctions that have broad international participation are more readily enforceable and generally more effective. Trade sanctions under the aegis of the United Nations can be far more effective than unilateral controls by one country. They are harder to circumvent, and more importantly, they carry the backing of international law and the force of international moral opinion. In recent years, the United Nations has backed imposition of economic and/or military sanctions on Afghanistan (under the Taliban), Angola, Cote d’Ivoire, the Democratic Republic of the Congo, Ethiopia and Eritrea, Haiti, Iraq, Liberia, Libya, Rwanda, Sierra Leone, Somalia, South Africa (under apartheid), Southern Rhodesia (now Zimbabwe), Sudan, and the former Yugoslavia.

The Impact of Export Controls on Business and Trade

The use of export controls and trade sanctions presents a policy dilemma. How does a nation control exports for reasons of national security or foreign policy without harming business, jobs, or economic interests?

This problem has two facets. First, if a nation restricts exports of goods that are widely available in world markets, then that nation’s exporters will simply lose the business to foreign competitors. It does not matter whether the goods are semiconductors, agricultural commodities, or something else. Moreover, the controls are unlikely to be effective as trade sanctions.

Second, placing unnecessary restrictions on exports of technology products, beyond those that are necessary to national objectives, could unduly burden a key economic sector. Nations must consider this when trying to keep weapons technology out of the hands of potential foreign enemies, outlaw nations, or terrorists.

Keep in mind the immensity of the problem. We are not just speaking of controlling the export of, say, one ready-to-use nuclear bomb. That is a big enough problem. We are talking about trying to control the thousands of bits of technology, knowledge, critical components, and radioactive fuel that rogue scientists could use to build a bomb. The same issue arises when we think about the fundamental components of outlawed chemical weapons or missile guidance systems. Imagine the thousands of parts that go into advanced military aircraft and other weapons systems, and the thousands of pieces of information one needs to build and run these systems. Having just one more critical component, or one more piece of information, can give a huge advantage to foreign military forces.

The problem is that many arms components are commercially available in the form of dual-use goods from competing suppliers in more than one country. Nations cannot control everything. The answer to the dilemma lies in knowing what to control, what not to control, who to keep it from, and how to control it effectively. This point was clearly expressed in an article, “Policing High Tech Exports,” which appeared in the New York Times on November 27, 1983.

The export-control process breeds ironies. Senator Paul E. Tsongas, Democrat of Massachusetts, used to tell the story of how the Ethiopian national airline, seeking to buy the latest model Boeing 767, was thwarted by the United States Government. If Ethiopia were allowed to purchase the plane, with its sophisticated laser gyroscope, the Government’s reasoning went, that gyroscope could fall into the hands of the Soviet Union, currently Ethiopia’s great friend. So the Ethiopians turned to the French for a new Airbus. The punch line: The American company that manufactures the gyroscope had already sold it to France, an ally, for incorporation into the Air-Bus. “We lose the technology, we lose the foreign business and we become known as an unreliable supplier,” Senator Tsongas argued. Ultimately, in this instance, such arguments prevailed: The Commerce Department granted Boeing its license in December 1982.

The fact that the Department of Commerce administers most U.S. export laws covering commercial and dual-use goods and technologies is a recognition that economic and business interests are in play. The United States does not prohibit the foreign sale of all technology, because that would not be practical or commercially possible. Rather, U.S. policy balances security interests with commercial necessity. A good example is the decision made by the U.S. Department of Commerce in 1999 to loosen restrictions on the sale of certain high-speed computer components to China, India, and Russia. High-speed computers can design nuclear weapons and run simulated tests on detonations, design advanced military aircraft and torpedo guidance systems, do three-dimensional modeling, calculate fluid dynamics, and perform other complex functions. In 1999, the New York Times reported that at a press briefing in the White House, then-Secretary of Commerce William H. Daley held a Sony Playstation in his hand and said that unless trade controls were eased, the new, more powerful Playstation 2, which was set to be released the following Christmas, would be classified as restricted due to its high-speed computer technology. The event dramatizes how the Department of Commerce must balance national security and commercial interests. To be fair, we should point out that the Clinton administration took a practical view of the problems with enforcing export laws. It changed its policy from using all of its resources, in an almost impossible effort to control the exports of all high-speed computers, which are produced at the rates of tens or hundreds of thousands per month, to controlling just those advanced technologies that it is actually possible to control. In 2002, President George W. Bush continued this policy by doubling the maximum speed of computer chips that could be exported. The effect was to permit export of computers 50 to 100 times faster than a typical home computer. This change recognized that as older technologies become widely available, export controls must keep pace with increasing computer speeds and other changes in technology. Similarly, the Bush administration loosened export controls on certain computer technology and software to take into account the reality that people travel with laptop computers. Strict controls, however, still prohibit export of all types of technology items to “state sponsors of terrorism.”

U.S. Agricultural Exports and the Soviet Invasion of Afghanistan.

One of the most famous examples of a failed unilateral use of export controls by the United States for foreign policy reasons occurred in 1979. The cold war was ongoing, and the Soviet Union had invaded Afghanistan. In retaliation, President Carter ordered an embargo of U.S. grain sales to the Soviet Union. This policy blocked the sale of millions of tons of American wheat. (In another bold move, he blocked U.S. participation in the 1980 Olympics.) President Carter had not garnered international support for the sanctions, and other countries did not back the United States. Major grain-producing nations, including Canada, Argentina, and Australia, continued to let their farmers sell to the Soviets. They did so and largely neutralized the embargo’s impact. The only result of the United States having unilaterally used food exports as a weapon of trade, other than the making of a moral statement, was the devastating economic impact on American farmers who lost a key market. Although President Reagan revoked the embargo, the damage continued for years. American farmers had lost their position as the principal suppliers of grain to the Soviet Union. Subsequent American presidents have been, or should be, far more aware of the importance of getting international support before imposing trade sanctions.

Export Restrictions on Crime Control Equipment.

The United States also uses foreign policy controls to prevent exports of crime control and detection equipment to repressive governments and areas of civil disorder. These items can range from handcuffs, polygraphs, and tear gas to mobile crime labs and shotguns. At first glance, one would wonder why the United States would do this. But imagine what would happen if certain products used by law enforcement agencies got into the hands of repressive governments, such as those in Burma (Myanmar) or North Korea. They could become implements of torture. They could also be used to disrupt public demonstrations, arrest protesters, eavesdrop and investigate political opponents, conduct interrogations, and commit other human rights violations. They may also have military applications. In addition to blocking exports to the most egregiously dictatorial governments, in recent years the United States has scrutinized exports of crime control equipment to Saudi Arabia, Russia, and Venezuela. In 2009, the United States approved over 3,600 shipments of crime control items valued at almost $1 billion, and denied 26.

Trade Controls for Reasons of Short Supply

Another reason why nations control exports is that certain critical goods or strategic raw materials may be in short supply. Short supply controls might apply to certain foodstuffs, medicines, basic metals, or natural resources. For instance, during wartime, a country might limit exports of copper, brass, or steel because it may need these metals for making arms or ammunition. Even during peacetime, short-supply controls are sometimes used to limit inflationary effects on the domestic economy caused by strong foreign demand for scarce resources or materials. U.S. law permits use of short supply controls to protect the U.S. economy from excessive foreign demand for scarce materials. As of 2010, the United States had short supply controls only on unprocessed Western red cedar from state and national forest lands. In 2005, one U.S. company paid a fine of nearly $500,000 for having exported cedar to Canada for treatment with preservatives and processing.

Trade Controls for the Protection of Wildlife, the Environment, Public Safety, or of Antiquities

There are many other reasons why nations may restrict exports. Many countries prohibit the export of certain wildlife or endangered species. Some countries prohibit the export of artifacts and antiquities. A good example is Egypt, which prohibits the unlicensed export of antiquities found at archaeological sites. Other countries regulate the export of chemicals, hazardous waste, materials for recycling, unsafe products, controlled substances and medicines, medical devices, nuclear material, and other items. Governments often regulate agricultural exports, as well as pesticides, herbicides, and certain fertilizers. Many of these regulations result from international treaty obligations.

HISTORY OF U.S. EXPORT CONTROL LAWS

The Continental Congress passed the very first U.S. export regulations, which restricted trade with Britain, in 1775. Later in America’s history, Congress enacted laws that controlled exports to enemies of the United States during time of war. Modern export control laws, however, can be traced to 1949 legislation enacted during the early days of the cold war and the communist threat. During the decades of the cold war, the United States cooperated with its allies in restricting any goods or technologies that could give any economic or military advantage to China, the Soviet Union, or the Eastern European communist countries under Soviet control. In 1962, because of the communist takeover of Cuba and the threat of Soviet influence in the Western Hemisphere, Congress strengthened the export laws. These tough controls reflected the view of the United States and its allies that they could counter the massive military buildup and troop strength by communist countries in the Soviet Bloc, and in Asia, by maintaining an enormous lead in military technology.

In the late 1960s, American export control policy began to take into account the need of American companies to be able to use their technological advantage to boost American exports. In 1969, a new export law relaxed controls in a number of ways. The most important change was that it required the government to consider whether a particular product or technology was already for sale, or available, from sources in a foreign country. It seemed to Congress that the law should not penalize U.S. companies or prohibit them from making a sale if the foreign customer could purchase the items from suppliers in other countries. This concept, known as foreign availability, still exists in our export laws today. (Today, the president is required to negotiate with any foreign country that permits the uncontrolled sale or export of sensitive technology to sponsors of terrorism, or to buyers in any other country hostile to American interests, in an effort to get them to control the exports also.)

In 1979, the export control laws were rewritten and enacted as the Export Administration Act of 1979. This law forms the basis of current export regulations. Following the Soviet invasion of Afghanistan in 1979 and the election of President Reagan in 1980, the administration embarked on a military buildup to counter what they viewed as Soviet aggression and expansionism. Eastern European communist governments were under Soviet pressure to tighten their political control.

In 1981, Poland declared martial law to suppress demonstrations by the pro-democracy group Solidarity and placed factories, mills, and shipyards under military control. In response, President Reagan attempted to tighten export restrictions on the Soviet Union, which he famously termed the “evil empire.” He also set out to strengthen international cooperation to keep critical goods, technology, and money away from the Soviet Union.

The Cold War “Cat and Mouse” Game: Spying and Industrial Espionage

During the cold war, communist governments had put all their resources into the development of their military and intelligence apparatus. It was a time of international intrigue, with agents of the Soviet Union, the former East Germany and Czechoslovakia, and other communist countries trying to obtain access to Western goods and technology by any means and at any cost. Spying had become their national obsession. Bribery, threats, and extortion were common tactics. They bought technological secrets wherever they could. In perhaps the most notorious case of the day, one of Japan’s largest and best-known companies was implicated in the sale of equipment and technology used to quiet nuclear submarines to the Soviets. This had devastating military consequences for the United States.

The Soviet bloc tried to steal what it could not buy. They planted “moles” in the United States and other Western countries. Women from Eastern Europe were placed in positions where they could meet men from the West, such as by posing as tour guides. They met men who had positions in government, academia, and industry and moved to America or Western Europe, where they could gather technical or industrial reports or information (referred to as soft intelligence). Industrial espionage reached epidemic proportions.

Consider this not-so-hypothetical example: A representative of a Soviet or Eastern European factory is visiting the United States as part of an industry delegation. It is arranged through appropriate U.S. agencies for them to visit an American factory to observe its production techniques. He asks to meet and chat with a lathe operator. Later, after the visit, the foreign visitor gives his shoes to a representative of the Soviet embassy for shipment to Soviet laboratories. The soles of the shoes had secretly been layered with a sticky substance. Soviet intelligence and metallurgists were interested in the company’s newly developed metal alloy, and the shavings were lying on the floor for the spy’s taking.

Illegal Diversions of Controlled Technology.

In export control terminology, a diversion is the unlawful transfer, transshipment, rerouting, or reexporting of controlled goods or technology from one destination, to which the goods or technology could legally be shipped, to another destination that has not been lawfully approved to receive the items. During the cold war, operatives from the Soviet Union or its Eastern Bloc allies would use companies (legitimate ones or “dummy” companies set up for this purpose) located in Western countries, perhaps in Europe, the Caribbean, or elsewhere, to place orders for U.S. products containing controlled technology. The goods would then be “diverted” to Soviet authorities or laboratories, where they could be analyzed, reverse engineered, or put to use. The purchasers may have offered to pay more than the asking price for the goods on condition that the American exporter would rush the shipment and forgo the “usual and time consuming” license application process.

In some cases, the American exporter was a complete victim of the scam. They may have gone so far as to obtain an export license. In other cases, the exporter may have been a willing participant in the game. The purchaser may have offered them a higher price for the goods, or even a cash bribe, to rush ship the goods without going through the license application and approval process.

Illegal diversions are still one of the most common, although criminal, methods used to circumvent the export laws and to deliver controlled goods and technology to countries that could be potential foes, or to individuals in those countries who would transfer that technology to international terrorist groups. Examples might include individuals in countries with whom the United States has good relations, such as Pakistan, China, Russia, or friendly Middle Eastern nations, with diversions of controlled technology going from there to countries such as North Korea or Iran.

Changes in the Export Environment since 2001.

With the fall of the Berlin Wall in 1989, the collapse of the Soviet Union in 1991, and the end of the cold war came three events that reshaped the political environment for export controls.

First, the rise of international terrorism and the terrorist attacks on the United States in 2001 created a “get tough” political environment in the United States and in other countries affected by terrorism. This led to new laws that gave the president and U.S. law enforcement agencies far-reaching, but controversial, powers to investigate, track down, and prosecute anyone aiding terrorists, and to stop the flow of money to terrorist groups.

Second, renewed concerns and tensions arose over nuclear proliferation, especially in North Korea and Iran. With the fall of the Soviet Union, there is concern that Soviet nuclear technology might have fallen into the hands of terrorists or rogue nations, or those who would sell it to them. There are also documented reports that Pakistani nuclear technology has spread to other countries and groups around the world, sold by unscrupulous scientists and businesspeople.

The third major change is that China has become a global economic powerhouse, and is not satisfied to remain merely the source of cheap labor for the world. It is a major purchaser of U.S. commercial technology and technology products. In 2009, nearly 10 percent of all export licenses issued by the United States were for exports to China. However, China is eager to acquire more then just commercial technology. It is also using any means possible to obtain the latest military and strategic technology for its nuclear forces, missile guidance systems, avionics systems, submarines, and space program.

The U.S.-China Economic and Security Review Commission, created by Congress in 2001 to monitor and report on the national security implications of U.S. trade with China, said in a 2007 report that Chinese espionage activities in the United States are so extensive that they comprise the single greatest risk to the security of American technologies. The report also warned of the vulnerability of U.S. companies and institutions to Chinese cyberattack.

Despite dire warnings, U.S. export policy with regard to technology exports to China balances the needs of business for open access to Chinese markets with the needs of national security. In recent years, the United States has loosened some controls on export of high technology to China, while significantly tightening controls and focusing enforcement efforts on those specific items that China could use to modernize its military.

Examples of Enforcement Actions

The problem of keeping goods and technology away from “the bad guys” is as great or greater today than at any time in the past. More and more developing countries, particularly in the Middle East, the Pacific Rim, and Central Asia, are trying to acquire missile and nuclear technology. These countries may still seek the knowledge and technology to produce chemical or biological weapons, despite international treaties. Some individuals may be acting on behalf of terrorist groups, or sympathize with their causes, while others are trying to acquire technology so they can sell it to the highest bidder. Some governments would gladly turn over their technologies to terrorist groups.

The Bureau of Industry and Security of the U.S. Department of Commerce, which is the lead agency for administering both national security and foreign policy controls, publishes a list of major cases. Here are a few examples.

Weapons of Mass Destruction: Nuclear Detonators to Pakistan. In 2005, a South African businessman was sentenced to three years in prison for conspiring to ship electrical switches and components with nuclear weapons applications to Pakistan. He had ordered the switches purportedly for a South African hospital for use in medical equipment, but arranged their shipment to a contact in Pakistan.

Terrorism/State Sponsors of Terror: Night Vision Equipment to Hezbollah. In 2006, a Lebanese-born Canadian citizen was convicted and sentenced to five years in prison and a $100,000 fine for providing material support to a terrorist organization. A sting operation caught him delivering advanced technology night vision goggles and laser sights for military rifles to an FBI agent. The items were to have been shipped to Greece and diverted to Hezbollah, a terrorist organization, in Lebanon.

Diversions to Military Use: National Security Controlled Electronics Equipment to China. In 2006, the Federal government convicted a Chinese resident of Wisconsin of money laundering and shipping $300,000 worth of semiconductors to China without a license. The items could be used in radar, communications, and missile technology. They had been delivered to Chinese institutes that do scientific research for the military. The defendant was sentenced to sixty months in prison, a $50,000 fine, and forfeiture of his Wisconsin home and $329,000 in cash. His wife and two other Chinese citizens were also convicted, imprisoned, and fined for their part in the conspiracy.

Multilateral Cooperation in Controlling Technology

In 1949, the United States, Canada, Japan, Western Europe, and a few of their major cold war allies formed a multilateral organization to cooperate in controlling exports. It was known by its acronym, COCOM. It was much like a basketball game, where one side tried to keep the ball away from the other, except that “the other side” was the Soviet Union and its Eastern Bloc allies. Each country could review licenses issued by other member countries and veto the issuance of a license. This facilitated trade between them because each country was assured that the other would prevent diversions. COCOM disbanded in 1994.

The Wassenaar Arrangement.

The Wassenaar Arrangement is an agreement between forty governments (as of 2010) including the United States, Canada, the eastern and western European countries, Japan, and Russia. Representatives meet periodically at permanent offices in Vienna to coordinate their export control strategies and to develop lists of items and technologies that should be controlled. Unlike COCOM, the countries in this group do not have a common enemy, and no single country has veto power over licenses issued by the others. This is a loose arrangement consisting of recommendations and statements of “best practices,” and reflects the lack of consensus about the level of control necessary in today’s world and divergent national interests. The lack of an effective international control system over arms and technology is worrisome to many policymakers. They realize that export controls by one nation are ineffective if the same technologies or weapons can be purchased freely on the open market in other countries.

Other Multilateral Export Control Groups.

The Australia Group is a group of forty-one countries that work together to combat the spread of biological and chemical weapons. They have set up a common list of controlled substances, equipment, and technologies that have weapons applications for nations to use in their licensing programs.

The Missile Technology Control Regime is a voluntary association of thirty-four countries committed to keeping missile technology from rogue regimes and terrorist groups that could use it to deliver weapons of mass destruction.

The Nuclear Suppliers Group is a group of forty-five nuclear supplier nations that includes the United States, Russia, and China. Its purpose is to share information and to set voluntary guidelines for countries that want to control the export and proliferation of nuclear material, equipment, and technology, especially that used in the enrichment and conversion of nuclear material.

The problem with these multilateral efforts is that they are voluntary and without enforcement powers. Nevertheless, they are an important way for nations to work together to address common terrorist threats.

EXPORT CONTROLS ON COMMERCIAL AND DUAL-USE GOODS AND TECHNOLOGIES

Earlier in the chapter, we studied export controls that apply primarily to arms, munitions, and defense systems. In this section, we are concerned with U.S. export controls and licensing procedures for commercial and dual-use goods and technology, and with compliance and enforcement mechanisms.

Export Administration Act of 1979 and Regulations

The Export Administration Regulations (EAR or “regulations”) were promulgated under the authority of the Export Administration Act of 1979 by the Bureau of Industry and Security (BIS), U.S. Department of Commerce. In 2001, the act expired and was not renewed by Congress due to political disagreements. However, the regulations remain in effect pursuant to executive orders of the president issued under the authority of another statute, the

International Emergency Economic Powers Act

of 1977. As of this writing, the Export Administration Act has not been renewed. The Export Administration Regulations are available through the Internet from the BIS or the U.S. Government Printing Office.

Commercial and Dual-Use Goods and Technology.

Earlier in this chapter we studied the Arms Export Control Act. That law applied primarily to controls on military and defense industry exports. The EAR, on the other hand, applies to the export and reexport of all commercial and dual-use items. (The term “item” is sometimes used to mean both goods and technology that are covered by the regulations.) Commercial items are those intended primarily for civilian use and include all goods and technology, not just those considered “high tech.” Commercial items might be controlled for foreign policy reasons, perhaps as part of a larger economic embargo (for example, to deprive comfort to nations that sponsor terrorism, seek chemical weapons, or suppress human rights). Dual-use items are commercial items that may also have military or “proliferation” uses (relating to the proliferation of nuclear, chemical, or biological weapons). These are usually controlled for military or strategic reasons.

The EAR defines technology as “specific information necessary for the development, production, or use of a product.” This includes proprietary research, but not research in the basic sciences for academic publication. The information can take the form of technical data (blueprints, models, specifications, etc.) or technical assistance (training, imparting working knowledge, and providing consulting services). The EAR applies to exports of software, encryption technology, and source code.

The following examples of dual-use items are taken from actual cases that resulted in convictions and sentencing for violations of the export control regulations: night-vision goggles, semiconductors, scopes for sporting rifles, electric cattle prods, thermal imaging cameras, oil drilling equipment, pipe-cutting equipment, high-strength aluminum rods, fingerprinting powder, common chemicals that are precursors of chemical weapons, advanced machine tools, medical and laboratory testing equipment that could be used to develop and test toxins used in biological weapons, parts for diesel engines that could become part of military vehicles or tanks.

Most dual-use goods and technology have commercial, civilian, or industrial applications that would not appear to have military or proliferation consequences. Indeed, in many cases, the engineers that designed them and the people that sold them would never have anticipated possible military uses.

Consider this example: An American firm formulates a new super-hard alloy for use in its advanced drill bits, intended for deep-earth oil drilling. The drill bits are sold to an oil exploration company in a foreign country so that it can tap its deep oil reserves and sell them to the United States. Then, a few years later, to the surprise of the American military, the foreign country rolls out a new tank with advanced armor that is almost impenetrable by ordinary anti-tank weapons. The armor, it turns out, was designed using the same technology that went into the manufacture of the drill bits, and the hardened alloy bits themselves were used to test the penetrability of the new armor.

Consider one more example: An American firm designs and manufactures a device commonly sold to highway engineers to test the depth of hardened road surfaces. A construction company in a foreign country places an order for the device. On further investigation overseas, the “company” turns out to be a front for a foreign government agency that is constructing a military airport runway in a strategic region of the world. They wanted the device in order to build a runway capable of handling their newest generation of military cargo aircraft.

The moral of the story is that American companies cannot rely on their own intuition as to whether their goods or technology are controlled and require government approval for shipment. They must know for certain and follow all procedures for licensing their exports.

What Is an Export and Reexport?

The regulations prohibit the export or reexport of controlled items. In this chapter, and for the purposes of export control law, the word export is an actual shipment of goods that are subject to the export regulations of the United States. The term also refers to any release of technology or software subject to the regulations in a foreign country, or to a foreign national, whether that person is located in the United States or in a foreign country. The term reexport has similar breadth, but it refers to the shipment or releases of American technology from one foreign country to another foreign country.

Authority for Prohibiting or Curtailing Exports.

Under the regulations, the Department of Commerce may “prohibit or curtail” the export of any goods or technology to any country in order to achieve the specified goals of national security, foreign policy, or the prevention of short supply of domestic materials. The Department of Commerce determines which items to control and places those items on the Commerce Control List. The Department of Commerce is required to consult with other executive departments (such as Defense, State, and Agriculture), the intelligence community, and multilateral control or coordinating agencies. The president establishes the list of controlled countries. The three broad goals of control are to maintain national security, implement foreign policy, and (where required) regulate commodities that are in short supply.

National security controls may be used to “prohibit or curtail” the export of goods or technology that would make “a significant contribution to the military potential of any other country or combination of countries which would prove detrimental to the national security of the United States.”

Foreign policy controls may be used to “prohibit or curtail” the export of goods or technology, where necessary “to further significantly the foreign policy of the United States or to fulfill its declared international obligations.” The president is required to consult with Congress and report on the effectiveness of foreign policy controls. The limitations are that the controls must be likely to achieve their purpose and capable of being enforced. On balance, the detrimental effects on trade, U.S. competitiveness, and the economic well-being of individual U.S. companies must not exceed the benefit to the U.S. foreign policy objectives. Export controls for foreign policy reasons are limited to a period of one year, after which they must be renewed by the president.

The EAR does not authorize banning the sale of medicines or medical supplies, or donations of goods for humanitarian needs (e.g., disaster response or aid to refugees). Exports of food or agricultural commodities may be controlled, but there are limits on the extent to which the president and the Department of Commerce may do this.

Short supply controls may be imposed where necessary to protect the domestic economy from the excessive drain of scarce materials or to reduce the serious inflationary impact of foreign demand.

One important hallmark of the export regulatory system is that the decisions of the president and of the Department of Commerce, including decisions as to which items to put on the Commerce Control List and which countries to sanction, are largely exempt from the usual administrative procedures of public comment and virtually immune from judicial review. In the past, courts have been unwilling to determine what goods or technologies should or should not be placed on the control list, what goods have potential military applications, etc. Judges have also recognized that if different courts around the country were to have different opinions as to what goods may or may not be exported without a license, the entire regulatory scheme would fall apart.

Foreign Availability.

Earlier in the chapter, we considered the economic impact of restricting trade for policy reasons. The regulations state that controls shall not be imposed for foreign policy or national security purposes on the export of goods or technology that “are available without restriction from sources outside the United States in sufficient quantities and comparable in quality to those produced in the United States so as to render the controls ineffective in achieving their purposes.” The government does not have to consider foreign availability if the president determines that the absence of such controls would be detrimental to foreign policy or national security.

The Export Licensing Process

Export licenses are issued by the Bureau of Industry and Security. According to the bureau’s 2009 annual report, in that year the agency processed over 20,000 export license applications worth approximately $62 billion. The largest single approval was for a shipment of crude oil worth $32 billion. The People’s Republic of China was the destination for the largest number of approved licenses: over 2,000 individual licenses worth more than $6.2 billion.

In the following section, we provide a very general overview of how to determine whether a license is needed for your export. Although businesspeople should know how to obtain a license, be sure to get competent professional advice if you are not experienced or have any questions. Civil and criminal penalties for failing to comply with the regulations can be very severe, a point to which we shall return. Never assume that your goods are not covered by the regulations or that their export is not controlled. No matter how innocuous your product may seem, it may require a license. Exporters are encouraged to consult the information and instructional materials available from the Bureau of Industry and Security or through its Website. Our discussion here applies to all commercial or dual-use goods that the Department of Commerce regulates.

Steps in Determining License Applicability.

An inquiry into whether a license is required for an export or reexport can have six possible results:

• A license is required.

• There is an exception to the license requirement.

• The export or reexport is permitted and has NLR (no license required) status.

• The export or reexport is not permitted to the country of destination.

• The export or reexport is not permitted to the end user.

• The export or reexport is not permitted for the end use.

The following ten steps are a basic overview of the licensing process for instructional purposes. Please do not rely on them for use in actual licensing. There is no substitute for reading the Export Administration Regulations and BIS rules. The BIS Website is an excellent source for additional information and examples.

To begin, you will need the following information in order to determine whether licensing requirements apply to your shipment (1) the classification of the item on the Commerce Control List; (2) the ultimate or final destination; (3) the end user (and whether it is someone with whom your transaction may not be permitted); and (4) the end use.

Step 1: Locate your item on the Commerce Control List (CCL). The CCL is available in the supplement to the Export Administration Regulations. There are ten general categories (which are also broken down into product groups):

0. Nuclear materials, facilities, and equipment

1. Materials, chemicals, microorganisms, and toxins

2. Materials processing

3. Electronics

4. Computers

5. Telecommunications and information security

6. Sensors and lasers

7. Navigation and avionics

8. Marine

9. Propulsion systems, space vehicles, and related equipment

Step 2: Using the listings grouped under each category, locate the correct Export Control Classification Number (ECCN) for your item by matching its technical characteristics and functions to the correct ECCN. The ECCN is a five-character alphanumeric code that tells the reasons and type of control for your item. If you prefer, you can submit an official request for the correct ECCN to the BIS through the Internet.

Step 3: Identify the “Reason for Control” for that ECCN. The possible reasons for control are listed in the CCL, beginning with the most restrictive (applicable to the most countries), and followed by their respective code: Anti-Terrorism (AT); Chemical & Biological Weapons (CB); Crime Control (CC); Chemical Weapons Convention (CW); Encryption Items (El); Firearms Convention (FC); Missile Technology (MT); National Security (NS); Nuclear Non-proliferation (NP); Regional Stability (RS); Short Supply (SS); United Nations Embargo (UN); Significant Items (SI); Surreptitious Listening (SL).

Step 4: Consult the Country Chart, found in the EAR, for each of the above reasons for control. The type of control for any item is determined by the reason for control and the country of destination. The fewest controls are over exports to Canada. The most restricted countries are the embargoed countries and those countries designated as supporting terrorism. All exports and reexports to embargoed destinations and to countries designated as supporting terrorism require a license.

Step 5: Determine if your item is classified as EAR99. The two main reasons for EAR99 classification are (1) the item is not on the CCL, and therefore has no ECCN (this usually applies to many commercial goods and consumer goods of low-level technology), or (2) the item is on the CCL, but a license is not required for the destination country. EAR99 items generally do not need a license unless the shipment is going to an embargoed or controlled country or to a suspicious or prohibited customer or end user, or is meant for a prohibited end use (e.g., one related to military uses, etc.). EAR99 items generally ship “no license required” (NLR), although that can change with the circumstances of the shipment.

Step 6: Determine if your item qualifies for a license exception based on the reason for control or the country of destination. If it does, determine the type of license exception, which you will use to prepare your shipping documents.

Step 7: Consult the regulations to determine if the end use of your item is controlled. If you think your item may aid in the proliferation of nuclear, biological, or chemical weapons, or missile technology, stop and inform the BIS. There are special end use and end user requirements in this area.

Step 8: Comply with all end user regulations. Regardless of whether your item is on the CCL, or whether you have found an exception, determine if your customer or end user is prohibited from receiving U.S. exports without a license. It is unlawful to release controlled items to anyone on the following lists. Consult these lists carefully.

Entity List: A list originally set up to bar exports or diversions to organizations engaged in activities related to the proliferation of weapons of mass destruction. Today it has been expanded for other reasons. Most end users on this list are in China, Russia, Pakistan, or India.

Specially Designated Nationals and Blocked Persons List: A list maintained by the Department of Treasury, Office of Foreign Assets Control comprising individuals and organizations deemed to represent restricted countries or known to be involved in terrorism and narcotics trafficking.

Unverified List: Firms for which an end use check could not be done in prior transactions. These firms present a “red flag” that exporters have a duty to investigate further. (For other “red flags” that are a warning of a possible illegal attempt to violate U.S. export controls, see Exhibit 13.1)

Exhibit 13.1: Red Flag Indicators

Things to Look for in Export Transactions

These are possible indicators that an unlawful diversion might be planned by your customer:

1. The customer or its address is similar to one of the parties found on the BIS list of denied persons.

2. The customer or purchasing agent is reluctant to offer information about the end-use of the item.

3. The product’s capabilities do not fit the buyer’s line of business, such as an order for sophisticated computers for a small bakery.

4. The product ordered is incompatible with the technical level of the country to which the product is being shipped, such as semiconductor manufacturing equipment being shipped to a country that has no electronics industry.

5. The customer has little or no business background.

6. The customer is willing to pay cash for a very expensive item when the terms of the sale call for financing.

7. The customer is unfamiliar with the product’s performance characteristics but still wants the product.

8. Routine installation, training, or maintenance services are declined by the customer.

9. Delivery dates are vague, or deliveries are planned for out-of-the-way destinations.

10. A freight forwarding firm is listed as the product’s final destination.

11. The shipping route is abnormal for the product and destination.

12. Packaging is inconsistent with the stated method of shipment or destination.

13. When questioned, the buyer is evasive or unclear about whether the purchased product is for domestic use, for export, or for reexport.

Reprinted from the U.S. Bureau of Industry and Security

Denied Persons: A list of persons whose export privileges have been denied or revoked. They may be located abroad or within the United States. If you believe a “denied person” wants to buy your goods in order to export them, you must not make the sale and should report it to the BIS.

Debarred List: This is a list of parties barred from exporting defense articles.

Step 9: Submit your license application on paper or electronically. Do not ship items until you receive the license.

Step 10: Prepare your shipping documents using the correct ECCN and the appropriate symbol (NLR, license exception, or license number and expiration date).

Most licenses are good for a period of twenty-four months. (Short supply licenses are good for twelve months.)

Licensing Review Process.

The BIS must complete the review of licenses within ninety days or refer it to the president. In 2009, the average time for approval of a license application was only twenty-six days (a time frame critical to U.S. firms waiting to ship to foreign customers). Many applications go to the Department of Defense for technical review. The BIS also coordinates with the Department of Energy (nuclear issues), the Department of State (arms issues), the Department of the Treasury, the U.S. Treasury’s Office of Foreign Assets Control (terrorist groups and state sponsors of terrorism), the Department of Interior (fish and wildlife, endangered species), the Food and Drug Administration, the Arms Control and Disarmament Agency, and with intelligence agencies (regarding end users seeking weapons of mass destruction). Interagency review committees are used if there is the possibility that an item can be used for missile technology or weapons of mass destruction. Interagency disputes lead to a high-level review process, and eventually to the president.

The Destination Control Statement.

The destination control statement (DCS) must be entered on the invoice and on the bill of lading, air waybill, and on some other documents that accompany the shipment to the end user abroad. The DCS is generally required for all exports from the United States of items on the Commerce Control List that are not classified as EAR99. At a minimum, the DCS must state: “These commodities, technology or software were exported from the United States in accordance with the Export Administration Regulations. Diversion contrary to U.S. law is prohibited.”

Special Comprehensive Licenses.

This is a special licensing process for companies that will make multiple shipments over an extended time for special reasons. This might include shipments of spare or replacement parts for items from previously licensed shipments; shipments to the same consignee for use in a major construction project; routine shipments to subsidiary companies, affiliates, or joint venture partners; or recurring shipments to foreign distributors who regularly do business in the exporter’s products. A special license requires advance registration with the BIS, approval of the consignee, and approval of a system of internal controls and record keeping to ensure compliance with the export regulations. Both the exporter and foreign consignees are subject to investigations by the BIS. Many controlled items are not eligible for special licensing.

Validated End User Program.

In 2007, the BIS began a test program to simplify procedures and speed shipments to eligible countries. It allows qualified exporters to preapprove foreign “trusted customers” and subsidiaries of American companies for shipments of certain high-technology, commercial, or dual-use items, without the need for individual export licenses. It is available to companies and end users that have a record of export compliance. It does not apply to any items that might have military or strategic value. Currently, the program is only used for exports to China and India. Critics claim that the program makes it too easy for controlled technologies to be illegally diverted.

Reexports of U.S. Goods and Technology.

U.S. export controls apply to both exports and reexports. The procedures for reexport licensing are similar to the procedures for an export license, although the circumstances requiring a license may be different. A reexport may require a license if the item meets one of the following criteria:

1. It was produced or originated in the United States.

2. It contains more than a specified percentage of U.S.-controlled content.

3. It is foreign made but based on certain U.S.-origin technology or software and is intended for reexport to specified destinations.

4. It was made by a plant located outside the United States if that plant was developed on U.S. technology, and if the item is intended for reexport to specified destinations.

Deemed Exports

Export controls for national security reasons apply to more than just shipments of goods. A deemed export is the communication or other transfer by an American citizen of technology, technical data, software, encryption technology, computer source code, or any other controlled information to a foreign national. A foreign national is an individual who is neither a U.S. citizen nor a permanent legal resident of the United States. Deemed reexports of information from someone licensed to receive it to a third person must also be licensed.

Applying the law is not always easy. Assume a citizen of India is a permanent legal resident of the United Kingdom and is working there. If he consults with an American subsidiary in England or in the United States, communications of controlled technology will be licensed to him just as it would be to a British citizen. Also, if a person has dual citizenship, the country of last citizenship applies.

Deemed exports fall under the export licensing laws. A U.S. company may require a license when communicating controlled technology or information to employees of foreign subsidiary companies, to foreign affiliates, to joint venture partners, to foreign engineers, consultants, or even to foreign customers. This can be a problem whenever U.S. plants, factories, research facilities, or offices, whether located in the United States or in a foreign country, are opened to visiting foreign customers and guests. The communication can be in any form, including a visual inspection or even casual observation of the controlled goods or technology. It also applies to Americans with technical knowledge and experience who could apply that to specific situations or projects in a foreign country without a license. It also applies to universities and research institutions that host foreign scholars and students. Proprietary research, including industrial designs the results of which ordinarily are restricted for corporate or national security reasons, are controlled. However, fundamental research (basic or applied) in science and engineering, which is research where the resulting information is ordinarily published and shared broadly with the scientific community, is not controlled or subject to licensing. Most technology companies and research universities have an internal control program to ensure compliance with the law.

The deemed export problem was addressed in a 2006 Report to Congress by the Government Accountability Office, Exports: Agencies Should Assess Vulnerabilities and Improve Guidance for Protecting Export-Controlled Information at Companies, (GAO-07-69). The report states in pertinent part,

In today’s global economy, U.S. companies’ exchanges of technology and information occur with ease and include the transfer of export-controlled technologies to foreign nationals through routine business practices such as

• transmission of a data file via an e-mail sent from a laptop computer, cell phone, or a personal digital assistant,

• using company electronic networks to make intra-company transfers of information to overseas subsidiaries or affiliates,

• visual inspection of U.S. equipment and facilities during company site visits,

• e-commerce transactions—sales of software over the Internet to overseas customers, and

• oral exchanges of information when working side-by-side with U.S. citizens.

According to BIS reports, in 2008 the agency processed 860 deemed export license applications. Most cases involved the electronics (semiconductor manufacturing), telecommunications, computer, and aerospace industries. Almost 40 percent involved Chinese nationals working in U.S. companies, followed by foreign nationals from India, Iran, Russia, Germany, and the UK.

Extraterritorial Jurisdiction of Export Control Laws

We begin this section with one of the most contentious questions in all of export control law: Should a nation, as a matter of law, be able to extend the power of its export control laws—its jurisdiction—over its goods and technology once they have left its territory? Most nations are not willing to say that goods and technology have “nationality” in the same sense that its citizens do. So the legal basis for extending jurisdiction over goods and technology once they leave the nation in which they originated is subject to debate. Most international lawyers reject the idea that one nation, in the absence of a treaty or convention, can control goods and technology within the borders of another nation. Consider a comparison to intellectual property law and the protection of patents, trademarks, and copyrights. We would not expect, for example, the UK to use its police and courts to take action in the United States to enforce a British patent that belongs to a British citizen. Such matters are usually covered by international treaty or convention, handled by local authorities under local law, or negotiated between governments. However, for at least a half century, the United States has attempted to assert the extraterritorial jurisdiction of its export control laws over its goods and technology anywhere in the world. The Export Administration Regulations state that they are applicable to “[a]ll U.S. origin items wherever located,” including “U.S. origin parts … or other commodities integrated abroad into foreign-made products.” In addition, the reexport provisions attempt to control U.S.-origin items long after they have left the United States. We have also seen this in the “deemed export” rules, under which the United States attempts to control and license the communication or transfer of technology by foreign subsidiaries of U.S. firms to foreign employees in foreign countries. In the example given in the following section, the American attempt to use extraterritorial export controls led to a serious international business crisis.

The Crisis over the Soviet Natural Gas Pipeline to Europe.

In the early 1980s, the Soviet Union and European countries agreed to construct a 3,000-mile natural gas pipeline from Siberia, across Russia and communist Eastern Europe, to Western Europe. It was the height of the cold war: The Berlin Wall divided Germany, and U.S. and Soviet tanks faced each other along the border between East and West. President Reagan and the United States stood firmly against construction of the pipeline. The U.S. fear was that it would make America’s allies in Western Europe too dependent on the Soviets, which could lead to disastrous consequences if war were to break out in Europe. It also would provide the Soviets with Western “hard currency” from the sale of gas, which would help take economic pressure off the Soviet Union’s failing communist economy.

American companies in the United States, as well as their subsidiaries in Europe, produced advanced technology that could be used in drilling and in construction of the pipeline. General Electric produced the most advanced turbines for moving the gas, although less effective alternatives were made by companies in the Soviet Union and elsewhere. Dresser France, S.A., a subsidiary of Dresser Industries of Dallas, Texas, produced gas compressors needed for the project. However, in an attempt to stop the project, President Reagan used the U.S. export control laws to order all American-owned companies and subsidiaries worldwide to refrain from exporting goods or technology for use in the pipeline project. The ban included goods and technology of U.S. origin, as well as those based on U.S. patents and technology licensed to foreign firms by American firms. France, Great Britain, West Germany, Italy, and other countries resented the order and considered it a “slap in the face” to their sovereignty. Their governments responded by making it unlawful for their companies to comply with the U.S. order.

Dresser was in a difficult position. The U.S. government threatened Dresser France, S.A. with sanctions, and possible criminal penalties, if it did not stop its shipment of compressors. The French government threatened to nationalize Dresser France, S.A. if it did. There was a diplomatic impasse. An article published in TIME magazine in 1982 quoted John James, Dresser’s chairman, as saying, “The laws of the United States are not the laws of the whole world.” President Reagan had no support, either at home or abroad. In the end, the Reagan administration’s attempt to assert the extraterritorial jurisdiction of U.S. export controls failed, and they were eventually rescinded.

Antiboycott Provisions

For our purposes, a boycott is an organized refusal of one or more nations, often backed by economic sanctions, to trade with one or more other nations. Boycotts are often used for political reasons. Antiboycott laws are legal responses by governments that make it unlawful for their citizens or companies to participate in a boycott. U.S. export control laws contain antiboycott provisions that make it illegal to “comply… [with or] support any boycott fostered or imposed by a foreign country against a country which is friendly to the United States.” Although the laws apply to any boycott not sponsored by the U.S. government, they primarily target some Middle Eastern countries that have been boycotting Israel for over fifty years. This boycott goes well beyond the Arab refusal to trade directly with Israel. Boycotting countries will not permit the import of any goods or services that have any Israeli components, and they will not do business with firms from anywhere in the world that also do business with Israel or that have ties to Israel. Firms that do business with Israel are “blacklisted.”

U.S. antiboycott laws apply to any U.S. person or company located in the United States. They also apply to foreign affiliates of such persons and companies. The laws prohibit participation in the Arab boycott of Israel, refusal to do business with blacklisted companies, or agreements to do so. They also prohibit the furnishing of information relating to the boycott, relationships with or in Israel, or relationships with blacklisted companies. In addition, the laws prohibit discrimination based on, or the furnishing of any information about, the race, religion, sex, national origin, or nationality of another person.

Any request for information related to a boycott, or request to participate in a boycott, must not be answered, but must instead be reported to the Office of Antiboycott Compliance within the Bureau of Industry and Security. Some of these requests are cleverly disguised. For example, a bank letter of credit issued on behalf of a Lebanese buyer for goods being shipped to Lebanon required a “[c]ertificate issued by the shipping company or its agent testifying that the carrying vessel is allowed to enter the Lebanese port….” This was a veiled attempt at enforcing the boycott on Israel, because ships that have carried Israeli goods, or that are Israeli owned, are not permitted to enter Lebanese ports. Violations of the antiboycott regulations by Americans are punishable under the export control laws. In the following case, Briggs & Stratton Corp. v. Baldridge, the court addresses a challenge to the U.S. antiboycott regulations.

Compliance and Enforcement

Compliance and enforcement are two sides of the same coin. No government agency, whether it collects taxes or fights water and air pollution, can rely solely on law enforcement to make the system work. Voluntary compliance by regulated companies is essential. Compliance with export controls is critical to national security. The exporter has the burden of using due diligence to comply with the law. Penalties for noncompliance are onerous.

Export Management and Compliance Programs.

One of the best ways to ensure compliance is for a company to establish an internal export management and compliance program. Such programs are virtually mandatory today. An effective program should be in writing and state company compliance policies, involve senior management as well as personnel at all levels, use trained personnel or outside specialists to implement the policy, provide for a system of internal audits to prevent and detect violations, provide for compliance throughout a supply chain, and have provisions for notification of the Bureau of Industry and Security in case of a question, violation, or other irregularity. The policies should cover procedures for internal security; licensing; use of “red flag” indicators and blocked persons lists; screening of foreign customers; investigating end use destinations, foreign travel, Internet, and local area network use; shipping; security at trade shows; and more. The system should also include controls over record keeping and reporting. Technology companies, research and development facilities, and research universities are a few examples of institutions that should—or must—have deemed export compliance programs.

Briggs & Stratton Corp. v. Baldridge

539 F Supp. 1307 (E.D. Wis. 1982), aff’d 728 F.2d 915 (1984) United States Court of Appeals (7th Cir.)

BACKGROUND AND FACTS

In December 1954, the League of Arab States called for an economic boycott of Israel. Under the “General Principles” worked out by the Arab states, a firm could be blacklisted if it traded with Israel.

The plaintiff manufactures internal combustion engines. Its products are often used as component parts. Briggs had been blacklisted because of dealings with Israel.

In May of 1977, Briggs received a letter from its Syrian distributor telling it that it had been blacklisted and refused an import license. He also received a questionnaire, which was translated as follows:

1. Has the company now or in the past had main or branch factories in Israel?

2. Has the company now or in the past had general offices in Israel for its regional or international works?

3. Has it granted now or in the past the right of utilizing its name or trademarks or patents to persons or establishments or Israeli works inside or outside Israel?

4. Does it share in or own now or in the past share in Israeli works or establishments inside or outside Israel?

5. Does it now or did it offer in the past any technical assistance to any Israeli work or establishment?

6. Does it represent now or did it represent in the past any Israeli establishment or work inside or outside Israel?

7. What are the companies that it shares in or with, their nationalities, and the size or rate of these shares?

Briggs answered the questions “no,” but did not have the questionnaire authenticated because of the new antiboycott regulations. The blacklisting continued, but subsequently the company was removed from the blacklist. Briggs was unquestionably injured economically by the blacklisting. Briggs brought an action against the officials charged with enforcing the act and regulations, claiming that they violated the First, Fifth, and Ninth Amendments to the U.S. Constitution.

DISTRICT JUDGE GORDON

… The Commerce Department regulations are consistent with this express policy to require persons to refuse to furnish information which would have the effect of furthering a boycott against a nation friendly to the United States. Thus the regulations are not inconsistent with the policies of the act.

I also reject Briggs’ argument that the regulations permit a firm to supply information in the absence of a questionnaire that it cannot supply if it gets one. Example (ix) following the intent regulation reads:

U.S. company A is on boycotting country Y’s blacklist. In an attempt to secure its removal from the blacklist, A wishes to supply to Y information which demonstrates that A does at least as much business in Y and other countries engaged in a boycott of X as it does in X. A intends to continue its business in X undiminished and in fact is exploring and intends to continue exploring an expansion of its activities in X without regard to Y’s boycott.

A may furnish the information, because in doing so it has no intent to comply with, further, or support Y’s boycott. 15 C.F.R. 369.1(e), Examples of Intent.

Briggs’ interpretation of this example goes too far. The example merely permits a company on its own initiative to demonstrate non-discriminatory conduct….

Briggs argues that because the regulations cause Briggs to be blacklisted, and thus affect its worldwide sales, the government has totally destroyed Briggs’ rights to its foreign trade. Briggs likens the effect to a restriction on private property which “forc[es] some people alone to bear public burdens which, in all fairness and justice, should be borne by the public as a whole.”

In Andrus v. Allard, the Supreme Court held that the denial of one traditional property right, where the others were not disturbed, did not always amount to a taking. In Andrus, there was no physical invasion or restraint on the property in question; the regulation only prohibited the sale of the property. The Court did not find dispositive the fact that the regulations prevented the most profitable use of the property.

When we review regulation, a reduction in the value of property is not necessarily equated with a taking…. [Ljoss of future profits—unaccompanied by any physical property restriction—provides a slender reed upon which to rest a takings claim.

The reed is equally slender here. The regulations apply to all Americans equally. It is possible that they have a somewhat greater impact on Briggs than they do on others, but that does not constitute a taking. Briggs has lost some profits because it has lost some sales, but its property has not been seized or restrained by the government. There is no restriction by the challenged regulation on Briggs’ efforts to export its products. In prohibiting Briggs from answering certain questions, the government has not taken Briggs’ property in violation of the Fifth Amendment.

Decision. The antiboycott regulations were upheld by the court despite the difficulties of compliance or the economic consequences that may result.

Case Questions

1. What is the purpose of the antiboycott regulations?

2. On what basis did the company challenge the act and regulations?

3. How should a company respond to a questionnaire like the one Briggs received here? What action should it take?

Record-Keeping Requirements.

Exporters are required to keep records related to all licensed exports for a period of five years. These include all licenses, license applications and supporting documents, bills of lading or transport documents issued by carriers, memoranda, notes, correspondence, contracts, invitations to bid, books of account, financial records, and other records of the transaction. In particular, exporters should keep all formal and informal records related to their investigation into their end users and the end uses of their exports.

Enforcement, Sanctions, and Penalties.

Export violations are subject to severe administrative and criminal penalties. The Bureau of Industry and Security (BIS) Office of Export Enforcement carries out investigations and may impose administrative remedies and civil fines. (In 2010, the Obama administration proposed moving criminal enforcement to the Immigration and Customs Enforcement Agency of the Department of Homeland Security.) The BIS may detain shipments, issue temporary denial orders (orders to prevent imminent illegal shipments), issue warning letters, and monitor compliance with the conditions of individual licenses. It may bring a civil action before an administrative law judge to impose civil fines or other administrative sanctions. Criminal cases are based on willful conduct or conscious avoidance, meaning that the exporter purposely avoided learning information (e.g., not asking if the goods will be resold and diverted) that might have had a bearing on his or her license application. Criminal investigations are handled by the BIS, the U.S. Bureau of Customs and Border Protection, the Immigration and Customs Enforcement Agency, the FBI, and often by the Internal Revenue Service, and are prosecuted by the Department of Justice.

It is unlawful to export in violation of the terms of a license, to evade licensing controls, or to buy, use, sell, conceal, or transport any item exported or to be exported from the United States with knowledge that a violation of the export laws has occurred, is about to occur, or is intended to occur in connection with the item. Other violations include soliciting the export of a controlled item; possessing a controlled item with intent to export or reexport it in violation of the law; altering a license; making false statements (usually in a license application, on the Shipper’s Export Declaration, or while submitting information electronically via the Automated Export System); failing to comply with a lawful order of the BIS; failing to comply with reporting and record-keeping requirements; and conspiracy. Many investigations also uncover crimes of money laundering.

Penalties for Export Violations.

Because the Export Administration Act expired in 2001, the penalties for illegal exports are those found in the International Emergency Economic Powers Enhancement Act of 2007. A person (individual, corporation, or business association) who willfully violates the export administration regulations, or the terms of any export license, (including a willful attempt or conspiracy to violate) is subject to a fine of not more than $1 million or if a natural person, may be imprisoned for not more than twenty years, or both. A civil or administrative penalty may be imposed for each unlawful violation of the export regulations in an amount not to exceed the greater of $250,000 or twice amount of the transaction that is the basis of the violation. For example, an employee of an exporting firm who willfully makes false statements on an application for an export license involving a shipment to a foreign customer worth $1 million could personally be assessed a maximum civil penalty of $250,000, a criminal fine not to exceed $1 million, and receive not more than twenty years in prison, per violation. (Many cases involve more than one violation.) In addition, the employing firm will be subject to similar monetary penalties.

Sentencing factors include the extent of the threat to national security, the number of shipments and their value, and the degree of willfulness and planning, and the experience and sophistication of the exporter. Anyone who makes an “accurate and thorough” voluntary self-disclosure of an export violation is likely to receive a reduced penalty as a result.

Denial of Export Privileges.

In addition to fines and imprisonment, individual violators and related parties can be subject to a “denial order” that bars them from exporting for a specified number of years. It is also unlawful for any other person to participate in an export transaction with a “denied person.”

THE PRESIDENT’S EMERGENCY POWERS DURING PEACE AND WAR

Congress has passed a number of statutes granting the president exceptional powers during times of peace and war. Since the American Civil War era, Congress has granted extraordinary powers to the president to deal with events that could be termed a national emergency, such as an international economic, diplomatic, or military crisis. Although originally conceived to allow the president to deal with economic problems that arise during wartime, the concept of national emergency has gradually expanded to include a broad range of situations affecting foreign affairs and international trade during peace or war.

Trading with the Enemy Act

Congress passed the Trading with the Enemy Act (TWEA) in 1917 to restrict trade with hostile countries during times of war. In 1933, however, President Roosevelt used this statute during a domestic economic crisis to declare a national banking emergency, close the nation’s banks, and prevent the hoarding of gold. Congress ratified the president’s actions and expanded the president’s emergency powers to include peacetime crises determined by the president to be “national emergencies.”

In the 1970s, Congress generally came to believe that the TWEA provided the president with far more sweeping powers to regulate peacetime emergencies than had ever been intended by the law. After all, this was the time of the “undeclared” Vietnam War. The excesses of presidential power were becoming evident as the Watergate disclosures and abuses of public office were made public. Executive actions of the president were considered suspect. In this climate, Congress sought to increase its role in making U.S. foreign policy and to impose new controls on the president’s actions during national emergencies. By 1977, Congress had passed new emergency powers statutes, and the TWEA lost its importance during peacetime, with the exception of the provisions that continued to restrict trade with Cuba and North Korea.

National Emergencies Act

In 1976, Congress passed the National Emergencies Act of 1976 (NEA), which ended four existing states of emergency and established new procedures for declaring new ones. (Ironically, the banking emergency declared by President Roosevelt during the Great Depression had remained in effect until 1976.) Under the NEA, the president can still declare a state of emergency, although the authority to act under it lasts for only one year. At the end of that period, the president must ask Congress to renew authority over that situation. The president must consult with Congress prior to declaring an emergency and report to Congress every six months while the emergency continues. Congress votes every six months on whether to continue the emergency and may terminate a national emergency declared by the president through a joint resolution of both houses of Congress.

Although the procedures for congressional oversight are set out in the National Emergencies Act, the powers and the scope of remedies available to the president are set out in the 1977 International Emergency Economic Powers Act (IEEPA).

International Emergency Economic Powers Act

This statute provides the current grant of authority to the president to regulate economic and financial transactions and to place restrictions on importing or exporting during a peacetime (or wartime) national emergency. The statute states that the president may declare a national emergency in the event of “any unusual and extraordinary threat, which has its source in whole or substantial part outside the United States, to the national security, foreign policy, or economy of the United States.” IEEPA allows the president wide discretion in controlling international financial transactions, including the transfer of monies, goods, and securities to and from the United States. It allows the president to seize foreign assets held in U.S. banks or foreign branches of U.S. banks. The statute also allows the president to impose a trade embargo with a foreign country and to take a wide range of other economic sanctions. The U.S. Treasury often implements the president’s policy decisions under IEEPA. Treasury regulations are published in the Federal Register.

Economic Sanctions under IEEPA.

Since its enactment, IEEPA has been used to impose economic sanctions against countries in every region of the world. Examples from the past few decades include Nicaragua, South Africa, Panama, Libya, Haiti, Serbia, Sudan, Burma (Myanmar), Afghanistan, Iran, and Iraq. Sanctions are usually tailored to the special problems presented in each country. One example was the U.S. ban on imports, financial transactions, and sales of computers, arms, and nuclear equipment to South Africa to punish it for its racist policy of apartheid in the decades prior to the 1990s. In the 1980s the United States imposed a ban on air flights between the United States and Nicaragua and a ban on Nicaraguan ships entering U.S. ports as a result of that country’s Marxist policies under its Sandinista government.

Under IEEPA, the United States imposed sanctions against Libya from the time it was deemed a state sponsor of terrorism in 1979 until 2004, when it renounced weapons of mass destruction and began complete cooperation with international weapons agencies. Presidents Clinton and George W. Bush have used IEEPA as a major weapon in the war on terrorism, using its authority to seize the assets of terrorist groups and cutting off their funding. As of 2010, the United States had ongoing economic and trade restrictions against the following countries for a variety of human rights abuses or for sponsoring terrorism: the Balkans, Belarus, Burma (Myanmar), Côte d’Ivoire (Ivory Coast), the Democratic Republic of the Congo, Cuba, Iran, Iraq, Lebanon, North Korea, Somalia, Sudan, Syria, Zimbabwe, and the former Liberian regime of Charles Taylor (of “Blood Diamond” fame, tried in 2010 at The Hague for war crimes and crimes against humanity).

As of this writing, the U.S. was enforcing other restrictions against certain persons, firms, or governments affiliated with terrorist organizations. These included any country attempting to interfere with the Middle East peace process; certain named individuals and organizations associated with the proliferation of weapons of mass destruction; and certain persons identified by the president as significant foreign drug traffickers under the Foreign Narcotics Kingpin Designation Act of 1999.

USA PATRIOT Act

One of the major U.S. legal responses to the terrorist attacks of September 11, 2001, was the enactment of a statute with a rather cumbersome title, Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (2001), commonly called the USA PATRIOT Act. The act made significant changes to IEEPA and other U.S. criminal statutes and gave far-reaching powers to law enforcement to deal with the threat of terrorism in America.

The act created new federal crimes and penalties for terrorism. These include new crimes (or increased penalties for existing crimes) for attacks on mass transportation, for harboring terrorists, for possession of biological toxins or weapons, for fraudulent charitable solicitation, and for providing material support to terrorists. The act also modified the immigration laws by giving the government greater freedom to detain and deport non-citizens where the U.S. Attorney General had reasonable grounds to believe that an individual belonged to a terrorist group or jeopardized U.S. national security. The act amended IEEPA to give the government greater flexibility to seize property of those who commit terrorist acts or who provide material support to terrorists. It permitted the president to order the confiscation of foreign property belonging to any individual, group, or country that planned, authorized, aided, or engaged in any attack against the United States. Moreover, it allowed assets of an individual or organization to be frozen pending (rather than following) an IEEPA investigation into its links to terrorists.

The PATRIOT Act amended U.S. laws on financial transactions and bank secrecy, so the government can better follow the trail of money supporting terrorists. The act expanded the record-keeping requirements for financial institutions (including banks, brokers, securities dealers, and other financial institutions) and called for greater government scrutiny over international business transactions. Financial institutions were placed in the position of “knowing their customer.” By consulting the government’s list of specially designated nationals and blocked persons, they could determine if any transaction included persons or organizations whose assets had been seized under the law. Financial transactions, both inside and outside the United States, were to be tracked and reported to the government whenever there was suspicion of money laundering for terrorist groups. Cash transactions over $10,000 also had to be reported. The law gave enforcement powers to the Department of Treasury, Office of Foreign Assets Control and the Financial Crimes Enforcement Network or FinCen, the Department of Justice, and various other government agencies.

The PATRIOT Act also provided law enforcement with greater investigative tools to fight terrorism while requiring less judicial supervision and oversight. It expanded law enforcement’s authority to conduct searches, permitted nationwide execution of search warrants against terrorists or those who harbor them, allowed the “roving” electronic surveillance of criminal suspects, permitted monitoring of some e-mail and computer messages without a warrant, and eased restrictions on law enforcement when national security was at stake. The act also expanded the extraterritorial application of federal criminal law to terrorist acts committed against Americans or American property overseas.

While the act was considered crucial in the government’s effort to prevent future terrorist attacks in the United States, it has also been criticized by many Americans for its broad and sweeping powers, especially those authorizing electronic eavesdropping, that some believe infringed basic American liberties.

IEEPA and UN Sanctions Against Iraq.

In 1990, shortly after the Iraqi invasion of Kuwait, President George H. W. Bush used his authority under IEEPA to impose economic sanctions on Iraq. He also used IEEPA’s protective measures to protect American and Kuwaiti interests. In an effort to stop Iraq from seizing and squandering Kuwaiti assets, the Treasury Department used IEEPA to freeze all assets of both countries that were held in U.S.-owned or U.S.-controlled banks and any other property held by U.S. firms. All sales between Iraq and U.S. companies were halted.

The Iraqi case presented a unique situation under IEEPA. The authority for U.S. action against Iraq in 1991 was broadened by international cooperation and by the force of international law. The United States was not acting unilaterally against Iraq; it was, rather, responding to calls from the UN for sanctions against Iraq. This case was also unique in that IEEPA sanctions were used to aid in the protection of foreign assets (those belonging to the government and people of Kuwait), not just to punish an offending country. The sanctions resulted in lost business, disruption of the international oil markets, blocked letter-of-credit transactions, and a regulatory nightmare for U.S. companies doing business in the Middle East. The first Gulf War began when the U.S. administration determined that the sanctions would not be effective. The administration of President George W. Bush lifted the sanctions in 2003 at the end of the second war with Iraq. Trade in arms, stolen cultural artifacts, and transactions with Baath party officials remained prohibited, and blocked Iraqi money was to be used in the rebuilding of Iraq.

Court Challenges to IEEPA

When Libya was implicated in international terrorism in the late 1980s, President Reagan prohibited U.S. citizens from performing any contract in support of commercial, industrial, or governmental projects there. In Herman Chang v. United States, 859 F.2d 893 (Fed. Cir. 1988), a group of petroleum engineers brought suit against the United States alleging that the termination of their employment with a Libyan oil company by an executive order under IEEPA violated their constitutional protection against the taking of private property without the payment of just compensation. In upholding the president’s order, the court dismissed the argument that the U.S. government may not act in an emergency in a way that causes economic harm to individuals or companies. The court stated,

A new tariff, an embargo, a [military] draft, or a war may inevitably bring upon individuals great losses; may, indeed, render valuable property almost valueless. They may destroy the worth of a contract. But whoever supposed that, because of this, a tariff could not be changed… or an embargo be enacted, or a war be declared?

IEEPA and the 1979 Iranian Revolution.

In the late 1970s, the government of Iran was overthrown during an Islamic revolution. Islamic militants, angry at the United States for its support of the prior government, seized the U.S. embassy in Tehran and held the Americans there hostage for 444 days. At the time, Americans and American firms had considerable business interests and property in Iran. That property was also seized by the new government. In response, President Carter declared a national emergency under IEEPA and froze all Iranian property (worth a total of about $12 billion) held by U.S. banks and corporations, both in the United States and abroad. All trade was halted and travel was restricted between the two countries. In order to free the hostages, the United States and Iran signed the Algiers Agreement in 1981, by which the United States agreed to place the blocked Iranian money in trust accounts in British banks pending the settlement of claims by the newly created U.S.-Iranian Claims Tribunal (which sat at The Hague, Netherlands). Chas. T. Main International, Inc., a U.S. engineering firm that had been doing work on an Iranian hydroelectric power plant, brought a legal action of its own in a U.S. court against Iran seeking compensation for its lost property, and a declaration that the Algiers Agreement exceeded the president’s powers under the Constitution. In Chas. T. Main International, Inc. v. Khuzestan Water & Power Authority, 651 F.2d 800 (1st Cir. 1981), the Court of Appeals ruled that the president had the authority to enter an agreement for the settlement of all claims between U.S. firms and Iran. The court further ruled that such an agreement prevailed over all other attempts by Americans to regain their property in courts of law. In ruling that the president had the constitutional power to create a tribunal to settle international claims, the court stated: “This case well illustrates the imperative need to preserve a presidential flexibility sufficient to diffuse an international crisis, in order to prevent the crisis from escalating or even leading to war.” Chas. T. Main had to proceed with its claim at The Hague, and it ultimately won an award against Iran there.

The Case of the “American Taliban.”

In 1999, President Clinton declared a national emergency to deal with the threat posed by the al Qaeda terrorist organization and by the Taliban (meaning “student of Islam”) government of Afghanistan, where al Qaeda training camps were located. The executive order prohibited the making or receiving of any contribution of funds, goods, or services to or for the benefit of the Taliban. The state of emergency was continued by President George W. Bush and remained in effect until after the successful U.S. military action in Afghanistan. During the war in Afghanistan, an American citizen by the name of John Walker Lindh was captured when it was discovered that he had undergone terrorist training in Pakistan and was fighting with the Taliban. He was charged in the United States with conspiracy to murder Americans, providing material support to foreign terrorist organizations, and violating IEEPA. In the following case, United States v. Lindh, the “American Taliban” challenged the International Emergency Economic Powers Act.

United States v. Lindh

212 F. Supp. 2d 541 (2002) United States District Court (E.D. Va.)

BACKGROUND AND FACTS

Beginning in 1995, both Presidents Clinton and Bush issued several executive orders under the International Emergency Economic Powers Act (IEEPA) declaring a national emergency in dealing with terrorism. Pursuant to those orders, the Department of the Treasury issued regulations prohibiting transactions with terrorist groups or providing services to them. Al Qaeda was named as a terrorist organization, along with the Taliban government of Afghanistan that supported them. Shortly after September 11, 2001, the United States invaded Afghanistan to locate and destroy al Qaeda terrorist training camps and to overthrow the Taliban government. During the war, it was discovered that the defendant was an American citizen fighting for the Taliban. He had undergone terrorist training in Pakistan and had allegedly met Osama bin Laden. He was charged in the United States under criminal statutes with conspiracy to murder Americans and with providing material support to foreign terrorist organizations in violation of the president’s IEEPA orders. Lindh argued that IEEPA applied only to commercial transactions with terrorist groups and not to his conduct.

ELLIS, DISTRICT JUDGE

* * *

Lindh argues that Counts Six through Nine of the Indictment should be dismissed because they charge violations of regulations that were promulgated in excess of the statutory authority provided by IEEPA. Specifically, these four counts charge Lindh with “Contributing Services to al Qaeda, Supplying Services to the Taliban,” and conspiracy to do each of these…. Lindh argues that IEEPA cannot be construed to authorize promulgation of any regulations prohibiting his voluntary and noncommercial donation of services to the Taliban and al Qaeda.

The IEEPA is a relatively recent addition to this country’s arsenal of sanctions to be used against hostile states and organizations in times of national emergency. For much of the twentieth century, this country’s sanctions programs were governed by the Trading with the Enemy Act (hereafter “TWEA”), enacted in 1917. As amended in 1933, TWEA granted the President broad authority “to investigate, regulate,… prevent or prohibit… transactions” in times of war or declared national emergencies. See Dames & Moore v. Regan, 453 U.S. 654, 672, 101 S.Ct. 2972, 69 L.Ed.2d 918 (1981). Congress changed this statutory scheme in 1977 to limit TWEA’s application to periods of declared wars, but created IEEPA to provide the President similar authority for use during other times of national emergency….

Despite the breadth of the Regulations and Executive Orders issued pursuant to IEEPA, Lindh asserts that IEEPA does nothing more than permit the President to freeze the assets of a foreign state or foreign national and prohibit certain international financial transactions during times of a declared national emergency. Lindh argues, moreover, that neither the plain meaning of IEEPA, nor its legislative history, indicate that it provides a basis for the wide-ranging regulations here in issue. Thus, Lindh argues, the Regulations he is charged with violating exceed IEEPA’s statutory grant of power.

The straightforward question presented, therefore, is whether the Regulations are within the scope of IEEPA. As this is a question of statutory construction, analysis must begin “as always with the language of the statute.”

The IEEPA language in issue is as follows:

[T]he President may, under such regulations as he may prescribe, by means of instructions, licenses, or otherwise—

A) investigate, regulate, or prohibit—

(i) any transactions in foreign exchange,

(ii) transfers of credit or payments between, by, through or to any banking institution, to the extent that such transfers or payments involve any interest of any foreign country or a national thereof,

(iii) the importing or exporting of currency or securities; and

B) investigate, regulate, direct and compel, nullify, void, prevent or prohibit, any acquisition, holding, withholding, use, transfer, withdrawal, transportation, importation or exportation of, or dealing in, or exercising any right, power, or privilege with respect to, or transactions involving, any property in which any foreign country or a national thereof has any interest; by any person, or with respect to any property, subject to the jurisdiction of the United States. 50 U.S.C. §1702.

This language manifestly sweeps broadly, as courts have consistently recognized in according deference to various sanctions programs under IEEPA and TWEA, see… United States v. McKeeve, 131 F.3d 1, 10 (1st Cir. 1997). (“IEEPA codifies Congress’s intent to confer broad and flexible power upon the President to impose and enforce economic sanctions against nations that the President deems a threat to national security interests.”) See also United States v. Curtiss-Wright Export Corp., 299 U.S. 304, 320, 57 S.Ct. 216, 81 L.Ed. 255 (1936) (noting that generally the President’s actions are entitled to greater deference when acting in the fields of foreign affairs or national security). This sweeping language provides ample authority for the issuance of the Regulations and also easily reaches Lindh’s alleged conduct. This conduct—which includes, for example, attending Taliban and al Qaeda training camps, using and transporting Taliban and al Qaeda weapons and ammunition, and using Taliban and al Qaeda transportation and residence facilities—plainly involves “use” of Taliban and al Qaeda “property.” And, given the breadth of the common dictionary meanings of “use,” “dealing,” “transactions” and “property,” there is similarly no doubt that Lindh’s provision of combatant services to the Taliban and al Qaeda also falls within the IEEPA and the Regulations.

* * *

Lindh seeks to avoid the result reached here by arguing that IEEPA concerns only commercial or economic conduct. In support, he cites the statute’s title and the fact that many cases involving IEEPA and TWEA address solely economic or commercial activity. This argument, while not implausible, is again contradicted by the statute’s sweeping broad language. As noted, the plain dictionary meanings of statutory terms like “transaction,” “dealing,” “use,” and “property” do not limit their use to commercial transactions; these terms are sufficiently broad to cover the conduct alleged here, including the donations of combatant services.

Decision. The provisions in the indictment alleging violations of IEEPA were valid. The plain language of IEEPA indicated congressional intent to grant broad powers to the president in times of a declared national emergency. The regulations issued pursuant to IEEPA applied to the rendering of combatant services to the terrorist organizations concerned.

Comment. In 2002, John Walker Lindh, known as the “American Taliban,” entered a plea of guilty to the charges and was sentenced to twenty years in prison.

Case Questions

1. What did Lindh do that led to his prosecution?

2. What conduct seems to be prohibited from a plain reading of the IEEPA statute? The name of the statute includes the words “economic powers.” Why is this significant to Lindh’s claim?

3. How does the court interpret the language of the statute? Does the court interpret the statute narrowly or broadly?

4. How does the court justify upholding Lindh’s prosecution?

U.S. Sanctions on Trade with Cuba

Prior to 1959, the United States had strong ties to Cuba, an island nation just 90 miles off the coast of Florida. Many Americans had business investments there, and the country was a mecca for tourists from around the world. In 1952, an army general seized power in a military coup d’état. Political unrest fermented, culminating with the 1959 overthrow of the government by Fidel Castro’s Marxist guerrilla army. Castro set up a communist government, with strong ties to the Soviet Union. Cuba nationalized the assets of American citizens and U.S. firms (including farms, factories, hotels, bank accounts, real estate, etc.) without compensation. Castro began an effort to “export communism” to other countries in Latin America and was a key player in the cold war between the United States and the Soviet Union. So began forty years of anger between the United States and Cuba, beginning with the failed Bay of Pigs invasion in 1963 and the Cuban missile crisis.

In 1963, the United States passed the Cuban Assets Control Regulations, under the authority of the Trading with the Enemy Act. The purpose of the law was to isolate Cuba economically and politically. It banned all trade and financial transactions between Cuba and the United States and froze all U.S.-held assets of the Cuban government and of private Cuban citizens. It also prohibited almost all travel to Cuba by U.S. citizens. (Certain researchers, student groups, journalists, athletes, and those traveling to see immediate family members in humanitarian need were excepted.) Although President Carter briefly loosened trade and travel restrictions with Cuba in the late 1970s, that changed with the election of President Reagan in 1980, who reinstated harsh sanctions. In the following case, Freedom to Travel Campaign v. Newcomb, a U.S. court ruled on the constitutionality of the Cuban travel restrictions and the Trading with the Enemy Act.

Cuban Sanctions after the Fall of the Soviet Union.

In 1989, the Soviet Union stopped supporting the Cuban government financially. No longer did it send billions of dollars of foreign aid annually. Many members of the U.S. Congress saw this as an opportunity to press Cuba for democratic change. First, Congress passed the Cuban Democracy Act of 1992, which tightened economic sanctions and travel restrictions by closing most loopholes in the law. The Cuban Democracy Act of 1992 stopped all travel and visits by family members and others, and it banned Cubans in the United States from sending money to their families in Cuba. Then Congress passed the Cuban Liberty and Democratic Solidarity Act of 1996, commonly called the Helms-Burton Act. The law authorized U.S. citizens with claims to confiscated property in Cuba to file private lawsuits in U.S. courts against any person, including a citizen of a foreign country, that traffics in (engages in any commercial activity regarding) that property. The most controversial part of the law required the United States to deny an entry visa to any foreign citizen who trafficked in property that was confiscated by Cuba after 1959. This included many Mexican, Canadian, and European businesspeople that did business in Cuba.

The passage of Helms-Burton caused a worldwide protest, primarily from Mexico, Canada, and the European Union, who argued that Helms-Burton violated international law. A protest was filed with the World Trade Organization by the European Union, but was suspended when the Clinton administration gave assurances that the visa restrictions of Helms-Burton would not be enforced against citizens of other countries. Helms-Burton calls for sanctions on Cuba to end once Cuba has a democratically elected government, abides by human rights conventions, opens its prisons to international inspection, returns Cuban citizenship to Cuban exiles living in the United States, and makes progress in returning expropriated property to its rightful owners. During the Clinton administration, the United States legalized sales of some food and medicines to Cuba, permitted travel to the island by religious groups and the media, and authorized direct charter flights. In 2009, President Obama lifted travel and spending restrictions for Americans with family in Cuba and on money that they can send to their families, as well as on telecommunications companies (in the hopes of getting more news and information to Cubans). Clearly, U.S. policies and public attitudes toward Cuba are very politically charged subjects.

Freedom to Travel Campaign (FTC) v. Newcomb

83 F.3d 1431 United States Court of Appeals (9th Cir. 1995)

BACKGROUND AND FACTS

Pursuant to the authority of the Trading with the Enemy Act (TWEA), in 1962 President Kennedy announced the Cuban Asset Control Regulations, which prohibited U.S. citizens from engaging in almost any economic activity with communist Cuba without a license. The embargo has lasted through nine U.S. presidents. The regulations at issue also restricted travel to Cuba. Certain persons, such as journalists and government officials, could qualify for a travel license. Permission for all other persons, including tourists, was only considered upon a showing of “compelling need” for reasons such as “educational activities.” Traveling to Cuba without a license was a criminal offense, and violators were subject to imprisonment, fine, and property forfeiture. The Freedom to Travel Campaign (FTC) is an organization that organizes educational and other trips to Cuba. It brought this action challenging the regulations. The FTC claimed that (1) the regulations violate the Constitution on the theory that the government lacks sufficient foreign policy reasons to prohibit a person from traveling to a foreign country; and (2) the failure to define “educational activities” for which travel is permitted renders the regulations excessively vague, and therefore void.

HALL, CIRCUIT JUDGE

FTC argues… that the Regulations’ travel ban is unconstitutional because the Government lacks a sufficient foreign policy rationale to inhibit FTC’s liberty interest in travel. In substance, this appears to be a substantive due process claim and we will treat it as such. A substantive due process claim involves the balancing of a person’s liberty interest against the relevant government interests [most citations omitted]. FTC claims that its freedom to travel is trampled by the Regulations’ travel ban. Although the freedom to travel internationally is a liberty interest recognized by the Fifth Amendment, Kent v. Dulles, 357 U.S. 116, 127 (1958) (“Freedom to travel abroad is, indeed, an important aspect of the citizen’s ‘liberty.’”), it is clearly not accorded the same stature as the freedom to travel among the states. Restrictions on international travel are usually granted much greater deference. Given the lesser importance of this freedom to travel abroad, the Government need only advance a rational, or at most an important, reason for imposing the ban.

This the Government can do. The purpose of the travel ban is the same now as it has been since the ban was imposed almost 35 years ago—to restrict the flow of hard currency into Cuba. That goal has been found [by other courts] “important,” “substantial,” and even “vital.” Thus, the Government seems to have satisfied its obligation.

FTC, however, would have us evaluate the foreign policy underlying the embargo. It contends that the President’s current reason for the embargo—to pressure the Cuban government into making democratic reforms—is not as compelling a policy for an embargo as were previous justifications that relied on national security concerns. FTC thus invites us to invalidate the ban. This is an invitation we must decline. It is well-settled that “[m]atters relating to the conduct of foreign relations… are so exclusively entrusted to the political branches of government as to be largely immune from judicial inquiry or interference.” See Regan v. Wald, 468 U.S. 222 (1984). This immunity manifests itself in a history of judicial deference.

Even were we to second guess the President, this is not a case where the Government has set forth no justifications at all. It has detailed numerous reasons for the embargo. We will look no further. The Cuban Asset Control Regulations’ travel ban is constitutional.

FTC claims that two provisions [on travel] are void for vagueness and therefore infringe upon its freedom to travel…. FTC correctly states that due process will not tolerate a law restricting the freedom of movement if its enforcement is left to the whim of government officials…. The Treasury Department’s recent amendment to the Regulations further cures any vagueness defects. Newly created Regulation 419 now defines “clearly defined educational activities” as (1) those conducted at an international meeting or conference; and (2) those related to undergraduate or graduate studies. Thus, this aspect of Regulation 560(b) is constitutional.

The FTC… argues that the Regulations’ vague language gives Asset Control officials the ability to arbitrarily interfere with its right to gather first hand information about Cuba, which its members would use to participate in the public debate about the wisdom of the Cuban-American embargo. When a person’s right to travel internationally is conditioned on the surrender of his First Amendment expressive or associational rights, the First Amendment is clearly implicated. However, where a person seeks only to gather information, no First Amendment rights are implicated.

Decision. The ban on travel to Cuba imposed by the Cuban Asset Control Regulations was valid. The U.S. government need only have a “rational basis” for prohibiting travel by Americans to foreign countries, such as in this case, where the ban was intended to deprive the communist government of hard currency.

Case Questions

1. What was the purpose underlying the ban on travel to Cuba?

2. What is the legal standard for determining whether the U.S. government can restrict international travel?

3. Why was the prohibition on travel not “void for vagueness”?

4. Consider the four cases in the chapter. Can you draw any general conclusions about the relationship between the individual and government with regard to the regulation of imports, exports, international travel, and even international commerce?

The Effectiveness of Cuban Sanctions.

Many people have condemned the Cuban trade and travel sanctions for their harshness. Even the Vatican protested Helms-Burton, claiming that it increased the economic suffering of the Cuban people. Many trade groups have argued against the law because they believe that economic engagement promotes freedom in totalitarian countries. U.S. firms wishing to do business in Cuba also seek an end to U.S. sanctions. Indeed, every year since 1992 virtually every member nation of the UN, except the United States and a few supporters, has passed resolutions calling on the United States to end the sanctions. Ironically, surveys of American public opinion show that the vast majority of Americans also favor ending sanctions and recognizing the communist government. Forty years of communism have left the island nation an economic ruin. However, a lack of necessities and consumer goods has not spurred a democratic uprising. Moreover, a study by the U.S. International Trade Commission released in 2001 revealed that the U.S. embargo has had only a minimal impact on Cuba, noting that the government tends to make trade and investment decisions based on ideology and political factors, not on economic considerations (see USITC Publication 3398, February 2001). Perhaps the argument against modern-day Cuban sanctions was expressed best by Arthur Schlesinger Jr., a noted U.S. historian and close advisor to President Kennedy, when he stated in a letter to the editor of the New York Times that “A better policy… would be to repeal Helms-Burton, lift the embargo and drown the [Castro] regime in American tourists, investments, and consumer goods.” New York Times, February 21, 1997, cited in Havana Club Holding v. Galleon, 961 F. Supp. 498 (S.D. N.Y. 1997).

CONCLUSION

For the United States, the pursuit of both export promotion and control will always be a deliberate balance between economic interests and foreign policy. It might be possible to have a country whose borders are impenetrable, whose technology products never reach the hands of an enemy, and who can stand by moral principles under all circumstances and refuse to do business with military dictators, communist regimes, or other despots. But the economic consequences would be disastrous. These are issues to be debated before Congress and pondered by the president. How can government best maintain America’s security in a dangerous world while fostering an environment for trade? Although there are occasional calls for America to “go it alone,” history tells us that international cooperation is the least dangerous solution.

As of this writing in 2010, the Obama administration has embarked on a reform of U.S. export control laws. The administration views this as a key part of its strategy to restrict the most critical technologies, while increasing U.S. exports of goods and technology not critical to national defense. U.S. manufacturers have complained that overly restrictive and unnecessary export controls have cost them billions of dollars in lost sales, especially on computers, aerospace, and dual-use products and technologies. The administration is restructuring the system to safeguard technologies that are critical to giving the United States a military or intelligence advantage, to protecting technology and know-how for creating weapons of mass destruction, and to protecting technologies that no other country can easily duplicate (such as making aircraft “stealth” or making submarines virtually “silent”). At the same time, controls will be eased on non-critical items that can be purchased anywhere (e.g., brake pads for Army tanks that are similar to those used on large fire trucks and are widely available). The U.S. munitions list and the commerce control list will be changed to describe items according to more objective criteria that is more easily understood and applied. The licensing process will be streamlined so that exporters clearly know what items are controlled, how they are controlled, and which government agency is responsible for licensing particular items. The administration is creating a single information technology system to improve the sharing of licensing and enforcement information between agencies, and it is creating the Export Enforcement Coordination Center to coordinate interagency enforcement of the export laws. The administration has also proposed combining all export control licensing under one agency, although this change would require new legislation. Many in Congress are not convinced that all controls should be put into the hands of one agency, especially given the fear of terrorism and nuclear proliferation.

Key Terms

U.S. munitions list 409

foreign policy controls 411

national security control 411

short supply controls 414

diversion 415

export license 415

Wassenaar Arrangement 417

Commerce control list 418

dual-use items 418

export 418

reexport 418

blocked persons list 420

specially designated nationals 420

debarred list 421

destination control statement 421

red flag indicators 421

deemed exports 422

special comprehensive license 422

extraterritorial jurisdiction 423

export management and compliance program 424

antiboycott 424

conscious avoidance 426

international emergency economic powers 428

Chapter Summary

1. U.S. trade in armaments, munitions, and defense systems is regulated by the Arms Export Control Act, administered by the U.S. Department of State.

2. The three primary reasons for control over exports of U.S. goods and technology are national security, foreign policy, and short supply controls to prevent excessive foreign demand on scarce materials.

3. Trade sanctions to achieve foreign policy objectives are generally more effective when done in coordination with other governments or in support of a United Nations resolution.

4. The United States controls the export and reexport of all goods and technology (including software and source code) whether they have commercial (civilian) applications, military applications, or dual-use applications. Dual-use goods and technology are those that have commercial uses, as well as military, intelligence-gathering, or other strategic applications. Nonproliferation controls apply to any goods or technology that can further the spread of weapons of mass destruction or missile technology. Diversion is the illegal transshipment, rerouting, or reexport of controlled goods or technology from a licensed destination to an unlicensed destination.

5. The U.S. Department of Commerce’s Bureau of Industry and Security (BIS) is the lead agency for administering the export controls over commercial and dual-use goods.

6. Export licenses are issued according to the item, destination, end user, and end use. All goods and technology on the Commerce Control List require a license for export or reexport, unless it is classified as EAR99 or there is a specific exception.

7. A deemed export is the communication or release, by any means, of any technology, technical data, or software to a foreign national, whether done in the United States or in a foreign country.

8. The antiboycott laws prohibit Americans from participating in, or responding to requests for information about, the Arab boycott of Israel.

9. Violations of the export control laws and the antiboycott laws are punishable by civil penalties, denial orders, criminal fines, and imprisonment. Criminal charges can be brought for both willful violations and conscious avoidance, which is purposely avoiding learning information about an end user, end use, or destination, in order to evade the export laws. Technology exporters should have a solid corporate compliance plan.

10. Perhaps the most important and effective way to comply with the export laws is for every organization with exports or deemed exports to establish an effective Export Management and Compliance Program. This is true for every company exporting goods or technology, and institutions or universities with foreign researchers, foreign faculty, or foreign students that are involved in research.

11. The International Emergency Economic Powers Act (IEEPA) gives the president authority to impose economic, trade, or financial controls during a declared international emergency. The president may seize assets, cancel contracts, impose export controls, and take a range of extraordinary actions. IEEPA was amended by the USA PATRIOT Act to grant exceptional powers against terrorist groups. This is administered by the Department of Treasury, Office of Foreign Assets Control.

12. Expect many changes in the system of U.S. export controls in 2010 and later years. The system will toughen controls and enforcement on items critical to U.S. military and intelligence gathering, while reducing confusion and delays in exporting noncritical items. There will be changes in the licensing process, and in the functions of some of the government agencies, that you studied in this chapter. Staying current on export control law is essential for anyone in international business.

Questions and Case Problems

1. Do goods and technology have “nationality”? What is meant by this statement? Do you think that a nation’s laws should apply to its goods and technology after they have left the territory of that nation? What principles of international law permit a nation to extend its jurisdiction over goods and technology that originated there? Can you make arguments for or against the extraterritorial application of export control laws? Does this differ from the extraterritorial application of antitrust law or laws against bribery of foreign government officials?

2. The International Emergency Economic Powers Act and the USA PATRIOT Act grant exceptional and extraordinary powers to the president to respond to almost any declared international emergency. Since the terrorist attacks of 2001, the United States has used these laws aggressively in the war against terror and against those deemed to be supporters of terrorist groups. Many Americans and civil libertarians view these laws with skepticism because they are easily subject to abuse by a president or law enforcement agencies. Based on your outside reading and knowledge, what are the pros and cons of granting emergency powers to the president for use against terrorism? Do you feel that the law has been used over-zealously, or has it given the president appropriate law enforcement tools needed to protect the nation? What do you think about their effectiveness against terrorism versus their potential for abuse?

3. Most readers are familiar with the debate over the use of trade sanctions as a means of carrying out foreign policy. President Carter’s ban of grain sales to the Soviet Union in response to the Soviet invasion of Afghanistan failed when the Soviets simply started purchasing grain from other countries. Shortly after that, President Reagan angered American allies in Europe, as well as American businesses, by unilaterally imposing controls on the sale of equipment for use by the Soviets in constructing the Trans-Siberian natural gas pipeline. Can you cite any examples where trade sanctions have worked? Under what circumstances do you think that trade sanctions are likely to work?

4. What is a “deemed export”? How can this impact technology companies and research institutions in the United States?

5. Daniel Bernstein, a graduate student, developed a software encryption program called “Snuffle” and wanted to post it on the Internet. The U.S. government said he needed a license. What was the result? How have the export regulations changed since Bernstein’s case?

6. Is it ethical to hold a businessperson legally responsible if he or she sells controlled technology to a second party that is then diverted to a prohibited end user? What factors will influence your answer? How does “conscious avoidance” affect one’s liability for an export violation?

7. Does the export of electric cattle prods require a license? Why?

8. Determine if and how U.S. export regulations apply to personal shipments made through the U.S. Postal Service or by air couriers such as FedEx or United Parcel Service.

9. What is the status of the Export Administration Act of 1979 and the Export Administration Regulations? Has the statute been renewed or replaced since its lapse in 2001? Are the regulations still in force? Have the civil and criminal penalties increased as had been proposed in 2007?

Managerial Implications

You are in charge of an American subsidiary company in France that manufactures advanced robotics equipment used in the automobile industry. You have engineering and research facilities in both countries. You receive an inquiry about your robotics from someone claiming to represent an upstart Chinese automobile manufacturer. He requests immediate information and explains that the plant is already well beyond the planning and financing stages and that things will soon begin to “move very quickly.” Answer the following questions.

1. Do the U.S. export regulations apply to your firm in France? Why?

2. Since this involves a potential sale to a customer, you question whether the U.S. regulations require an export license just to disclose some technical information. Does it? Explain.

3. How do you respond to his request for information? How much information may you give to him without a license? At what point do you have to stop? Explain.

4. You know that if you have to apply for a license, you will need more information about this individual, his company, and its location, the end use of the product, and the ultimate destination. How would you obtain that information? What sources would you use? Are there any industry, government, or banking sources that could help you? What special precautions would you want to take to ensure that his inquiry is legitimate and honest? Explain.

5. You and your prospective customer decide to meet and go over engineering and technical specifications. What steps must you take before the meeting to ensure compliance with the law? Does it matter whether you are meeting in the United States, France, or China?

6. It is some time later, and having worked out all necessary arrangements, you are ready to ship and arrange installation of your first pieces of equipment. In the interim, with no apparent provocation, China refuses to allow a U.S. naval ship to make a prearranged stop in Hong Kong. There are 1,000 sailors aboard who hope to spend Christmas with their family members, who have traveled all the way to Hong Kong for the holidays. You apply for a U.S. license with the BIS, and it is turned down based on a new ban on the sale of certain items to China, including robotics. You exhaust the administrative appeal process. Do you have any rights against the BIS? Are you protected by the U.S. Constitution, since they changed the rule just prior to your shipment date?

7. The French government is very interested in your company making the sale. The President of France considers it a technological coup d’état. On learning that the United States blocked your sale, he threatens to fine your company up to five times the value of the shipment and to throw you in a French prison. What do you do? Do you comply with the laws of the United States or the laws of France? What are the alternatives?

Ethical Considerations

1. Your company, Ajax Pharmaceutical, based in New Jersey, is approached by an agent for a company that has offices in Egypt and Jordan about participating in several joint ventures in the Middle East and Asia. The agent inquires about the status of your investment in Israel. You currently have an offer from a newly formed Israeli investment group to purchase your 30 percent share of Drugisco, an Israel-based company. How do you respond? What is your legal obligation? What other information do you need to answer the agent’s question? He also asks about your ability to ship certain chemicals that are controlled. Do you have any obligation to report this inquiry? You initially ship the requested items to Japan. You discover during a late-night meeting in a karaoke bar that these items went to a middleman and are now headed to Sudan. Do you have any legal responsibility? Ethical responsibility? What managerial controls can you implement to reduce the likelihood of this happening in the future?

2. Your company, Enzyme, Inc., manufactures biological and chemical agents that have potential military uses. You understand that Congress is considering the contentious issue of how to revamp the entire export control regimen. Prepare a letter to your state’s senators articulating your company’s position about decontrol. Do you think your company should take an active role in lobbying for a new law? What are the risks associated with such a position? Will you discuss these issues with your board of directors?

(Schaffer 408)

Schaffer, Agusti, Dhooge, Earle. International Business Law and Its Environment, 8th Edition. South-Western, 2011-01-01. .